OWINGS MILLS, Md. (TheStreet) -- Small-cap investing is fraught with risk.
The size of the companies makes wild price swings common, since thin trading results in big price changes from sell orders that may overwhelm buy orders, and from speculative traders. A recent Under the Radar pick,
, has been a victim of such volatility. Medifast has lost about 10% of its value since its initial recommendation. However, the stock appears to have been battered by rumors and speculative trading.
Based in Owings Mills, Md., Medifast sells portion and nutritionally controlled food to aid in weight loss, similar to the programs offered by
. Medifast has soared more than five-fold in the past 52 weeks, while NutriSystem has increased 23% and Weight Watchers has risen 38%.
A four-week supply of Medifast food is priced at $299.50, or almost $11 a day. The company claims the average adult spends $16 a day on regular food. Plan participants reduce their caloric intake to around 1,000 calories a day, losing 2 to 5 pounds a week.
Success stories on the Medifast Web site featuring users who have lost up to 255 pounds make it easy to see why the company is enticing for overweight people struggling to lose unwanted pounds. While many would argue that traditional diet and exercise is a more effective and longer-lasting solution to weight problems, there are still a huge number of overweight Americans willing to shell out for products that require less of a sweat commitment.
Analysts are projecting revenue growth of 40% in 2010 and 24% in 2011. This explosive growth comes at a time when similar diet companies like NutriSystem and Weight Watchers are suffering a pullback in revenue projected to continue through 2010 before increasing slightly next year. This is the source of much of the trepidation about Medifast's sustainability and business practices.
Accusations have been levied that Medifast's model is unsustainable and dependent on its Take Shape for Life segment, which uses personal coaches to sell its products. While the unit accounts for most of Medifast's income, it's hard to imagine the company is dependent on coaches.
In terms of hard numbers, Medifast boosted its cash hoard to $12.7 million from $1.8 million in the fourth quarter of 2008, leading to a current ratio of 6. The company has minimal debt financing, reflected in its debt-to-equity ratio of only 0.21. Weight Watchers is in a much more risky financial situation, with a negative equity position and a huge reliance on long-term debt financing.
Despite its low leverage level, Medifast has managed to post a return on equity of 26.3% with an operating margin of 11.3%. These attractive performance numbers make the Medifast model look sustainable.
Due to volatility risk, it would be wise to pare holdings in Medifast. The stock looks attractive from a fundamental standpoint, but the risks must be respected, so only a small allocation should be made to a stock as volatile as this one.
-- Reported by David MacDougall in Boston.
Prior to joining TheStreet Ratings, David MacDougall was an analyst at Cambridge Associates, an investment consulting firm, where he worked with private equity and venture capital funds. He graduated cum laude from Northeastern University with a bachelor's degree in finance and is a Level III CFA candidate.