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Should You Eat Up Diet Stocks?

You may as well profit from dieters' endless struggles


I believe the world’s most hated activity is dieting. I also believe that it is the single most unsuccessful New Year’s resolution in the history of mankind. And let’s face it, dieting stinks. Who doesn’t want to stuff their face, especially with ice cream? The good news is that if you can’t stick to a diet, at least you can profit from other people’s failures in the form of dieting stocks.

The dirty little secret of the diet industry is that diets are designed to fail. This is great news for diet companies. They get you to keep coming back to try again to quit your bad eating habits. They’re complicated, they depend on strict adherence, and worst of all, they deprive. Human beings don’t do well with deprivation. How many people do you know who have dieted, lost weight, and kept the weight off? However, if you are a diet company, and your message is sufficiently different from that of your competitors and you have a great brand presence, you have a chance to rake in cash.

So are any diet stocks worth buying?

The biggest brand name is, of course, Weight Watchers International (NYSE:WTW). The company has been on a tear of late. Even dieters, apparently, threw in the towel during the financial crisis and withheld their discretionary income from Weight Watchers’ various fee-based products. FY 2009 net income fell 15% over the previous year, but then popped up 10% in 2010, and through only three quarters of 2011 net income was up a whopping 25%, with Q4 waiting to be reported. With Americans’ obsession with health only becoming more intense, it’s no wonder analysts see 14% annualized growth over the next five years. The company does carry a billion dollars of debt (consider it their “fat”), but with free cash flow of a quarter million every year, that’s not a concern. The company trades at 16x earnings, however, and that makes it fairly priced for the moment.

I’ve always been intrigued by smaller, scrappier companies, and in the diet world, that mantle belongs to Medifast (NYSE:MED). You might be surprised to learn that the company has been around for 30 years and has taken the slow, methodical approach to building its brand. Unlike Weight Watchers, Medifast grew its earnings during the financial crisis. The company is slated to grow 17% annually. Best of all, it has only $4 million in debt while generating modest free cash flow of around $15 million each year. The stock, however, trades at only 10x earnings, giving it a PEG ratio of 0.65 — well within value territory. I think Medifast is a great small-cap value play here.

Herbalife (NYSE:HLF) is also faring quite well. It’s even larger in market cap than Weight Watchers at this point, and annualized growth is pegged at 14%. Like its larger rival, it got tagged in 2009 but roared back in 2010, with a 45% net income jump. At the moment, the company has already matched its 2010 earnings through three quarters, so Q4 will make it another year of growth — possibly as high as 30%.  With more cash than debt, and free cash flow last year of over $300 million, Herbalife is on solid ground.  It also looks fairly priced, however, at around 16x earnings.

Of course, you’ll want to dig into financial reports and check into things like inventory. If inventory of raw materials is on the rise, that’s a good sign that demand remains high. If inventory of finished goods is rising at a significantly higher rate than revenue, that may suggest demand is slipping.

Lawrence Meyers does not own shares of any company mentioned.

Article printed from InvestorPlace Media,

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