Medifast, Inc. (NYSE:MED)

CAPS Rating: 3 out of 5

The Company is engaged in the production, distribution, and sale of weight management and disease management products and other consumable health and diet products.

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Player Avatar CaptBS (96.41) Submitted: 1/11/2010 3:08:49 PM : Underperform Start Price: $14.25 MED Score: -46.55

This one is a hard call. On one hand, it's hard to argue with results: Medifast has reported consistent and staggering revenue growth over the last 9-10 months, in spite of a crippling recession and precipitous drop in discretionary consumer spending. Over this period, the stock has gained a whopping 800+% without any significant pullback. Is this incredible run indicative of runaway success that will continue for some time to come, or is it a warning sign of a bubble that's about to burst?

As you may have guessed from the red thumb, I'm a little suspicious of this company's valuation (currently: 46+ P/E and 10 P/B). Although the last few quarterly reports have indeed been impressive (TTM EPS growth of 121% stands out), I see a few red flags with respect to this stock and the way the company does business. Most simply, from a technical perspective, the stock is long overdue for a significant price correction, as there has been virtually no selling pressure on an average volume of about 500K - 1M shares over the past year.

More importantly, the sustainability of the company's business model strikes me as questionable, as Medifast has derived an increasingly large part of its revenue from its "Take Shape for Life" coaching program. Although this program is one of the company's main differentiators, its capability to generate new revenue relies heavily on the ability of its weight-loss coaches to recruit other coaches and clients (for a commission). Some have gone as far as calling this a pyramid scheme (take your favorite salt-shaker to www.medifraud.net), but whether or not you agree with that assessment, the key takeaway is that the revenue from this line of business will eventually plateau, if not enter into a downward spiral.

Finally, the scandal involving the CEO aggressively pumping Medifast's stock on the Yahoo Finance message boards and the overly defensive, vitriolic press releases that the company tends to issue in response to any perceived attack on its public image make me wonder about Medifast's corporate culture... I just can't imagine Weight Watchers or Jenny Craig engaging in this type of behavior.

In the end, Wall Street primarily cares about numbers, and so far, Medifast has certainly delivered on that front. Although the company's torrid growth may continue for another quarter or two, sooner or later (and I would guess sooner) the stock will run into some significant resistance from both a technical and revenue-growth standpoint. When that happens, expect the share price to trim a significant amount of fat.

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