Reality Check Halts Momentum at Martha Stewart

When it comes to Martha Stewart Living (MSO), investors seem to be having trouble distinguishing the hope from the hype.

Is the struggling company poised for a turnaround, boosted by a potentially breakthrough television hit? Or has the latest buzz around the company obscured the fact that Martha Stewart Living is still reeling from the felony conviction of its namesake founder?

After the company's stock soared as much as 76% over the last two weeks, the skeptics' argument seems to be regaining the upper hand. The stock fell more than 10% Monday after dropping 3% on Friday.

"This stock has traded so much on emotion," said Jamelah Leddy, an analyst with McAdams Wright Ragen. (Leddy does not own shares of Martha Stewart Living and her firm does not do investment banking with the company.)

Much of the upswing can be attributed to a short squeeze triggered by two announcements: Stewart will serve her prison sentence early, and the company signed a deal with TV producer Mark Burnett to develop new programming.

But the company's latest news will do little to reverse the company's current losses, William Drewry, a Credit Suisse First Boston analyst, said in a research note Monday. "The stock has disengaged from fundamental reality once again, and we would use the opportunity to take money off the table," Drewry wrote. (CSFB does not do investment banking business with Martha Stewart Living and Drewry does not own shares in the company.)

Nearly everyone agrees that the current reality is dire. The company has seen revenue plummet and the bottom line deteriorate since Stewart was caught up in a questionable stock trade.

Earlier this year, Stewart and her stockbroker were convicted on obstruction of justice charges related to the investigation in her trade of shares of ImClone Systems (IMCL). Stewart still faces civil insider-trading charges related to the stock sale that were filed by the Securities and Exchange Commission.