*** I talked to my cousin Michael last night via instant messenger. He said he was fed up with his current living situation and wants to start up his own business. So I asked him what he wants to do.

“I’m not sure if it I would start my own property management company or run an ambulance service business. But it has to be a service, I know that. And I’m leaning towards the ambulance gig. After all, there are millions of baby boomers. And eventually, they will need an ambulance…for something.”

Michael went on to say…

“Hell, my cousin runs an ambulance company — and he’s a dumbass. He has the business sense of a baboon. Yet he does very well for himself. And I’m a workaholic. If I planned this out right, I am pretty certain it would work out nicely.”

Your Penny Sleuth was intrigued. Michael’s argument made sense to me — in a sophomoric sense. Of course, I would never go into business for myself until I’ve thoroughly researched the risks and rewards of the industry. And I wouldn’t base my chances for success off another “dumbass” cousin who happened to walk into a gold mine. But there just may be something to Michael’s logic.

Fist of all, services make up about 80% of our nation’s GDP. And Unz & Co., an international trade expert that opened up shop in Manhattan in 1879, says…

“Looking into the future, the service sector looms ever larger in the U.S. economy. This services-driven business expansion is overwhelmingly led by small, entrepreneurial firms, those firms employing fewer than 500 employees. Small services companies account for more than 41 million jobs.”

Second of all, the total number of Americans who are 50 years or older is expected to grow as much as seven times over in the next 15 years. And according to the Federal Reserve Board, these baby boomers account for 70% of the net worth in our wonderful country.

Sounds like Michael may have an idea worth looking into. So I wondered, is there a way to make money off this idea on Wall Street?

Turns out, there is a fund manager who is thinking just like Michael.

*** Robert Male’s Buffalo Small Cap Fund beat 97% of all mutual funds last year, rising 29%, according to Danielle Kost of Bloomberg News. In fact, over the last five years, the fund has averaged 17% compounded annual returns. Not too shabby. During that same time, the Russell 2000 index has averaged 4.64% gains.

So how has Male managed to beat the rest of the market?

Simple: He looks at major demographic trends developing in the United States, and he invests in companies that should directly benefit.

According to the Bloomberg report I read, “Baby boomers, those born between the end of World War II and 1964, accounted for about 28% of the U.S. population in 2000, according to the Census Bureau. People under the age of 18 made up 26% of the population in 2000.”

Those are some pretty large trends — which is exactly why Male invested about half his $2 billion in assets in consumer and health care companies like Pharmaceutical Product Development – a drug discovery company — and INAMED Corp. — which makes breast implants for those not quite happy with their God-given busts.

Personally, your Penny Sleuth doesn’t understand why anyone would want silicon balloons in her chest. But that’s neither here nor there. The point is…

As investors, those with a well-crafted plan and the guts to stick by it through thick and thin should outperform the rest of the herd. Male has certainly proved that.

In 2002, his Buffalo Small Cap Fund lost 26%. But he didn’t panic or start blaming people for his “failure.” Rather, he stayed invested. He had a longer term horizon than most investors. And it paid off. In the last three years, his total assets have grown from $770 million to $2 billion.

Speaking of a picture of health…

*** My colleague Chris Mayer, editor of Fleet Street Letter, wrote in saying, “I am bullish on a company with concrete slabs with 300% profit margins. This company owns 120 hydroelectric dams on various river systems located primarily in the United States and Canada, and also in Brazil — essentially, concrete slabs that ooze with profit.

“The operating costs of these dams run about 1 cent per kilowatt hour, and the company charges about 4 cents per kilowatt hour, making it one of the lowest cost producers of electricity in North America.

“There is much more to this company, virtually a cornucopia of wealth-generating assets. For example, the company owns over 40 million square feet of prime office property in the business hubs of North America and London, among the most expensive real estate in the world.”

*** At Penny Sleuth we’re going to keep trying to spot the big trends for you — so you can maximize your own investment returns. In fact, I am working with Angela Roberts, the editor of Penny Stock Fortunes, on finding a company that will benefit from the aging baby boomers. More about that in coming months. But for now, Irwin talks about getting phat…

Get Phat on Diet Small Caps

I never make New Year’s resolutions. I’ve always figured that if I worked hard, stayed focused and got the occasional peck on the cheek from Lady Luck, things would go my way. But on New Year’s Eve 2004, surrounded by friends at a swanky party in a Victorian mansion with a view of its lighted swimming pool and carriage house, I broke
down and did it — becoming another statistic in an industry ripe for small-cap investors.

Having gorged myself that night on appetizers of caviar, sour cream and chopped eggs on miniature potato pancakes, along with toasty baguettes with pate and stinky cheeses…followed by glazed ham, crispy duck with plum sauce, beef bourguignon, leg of lamb, grilled sea bass, garlic mashed potatoes, candied carrots, and asparagus almandine in lemon-butter sauce…and then shoveling in flourless chocolate torte, carrot cake with thick cream cheese frosting, apple pie and petits fours…all washed down by a river of Veuve Clicquot champagne and Germain-Robin cognac…as the poppers, kazoos and streamers burst through the house at midnight…my belt at the very last notch feeling like a deadly garrote around my waist…I took the leap and vowed to lose weight in 2005.

Even though I’m a bit porky, it could be worse. There are many Americans who really are in awful shape. Of all adults, 64% are either overweight or obese, according the National Center for Health Statistics. One in eight deaths in America is caused by an illness directly related to overweight and obesity. And obesity contributes to our nation’s biggest killer: heart disease.

Personally, I fall into the category of someone who finds that 25 pounds have snuck up on him over the years. So New Year’s Eve becomes a momentous occasion for turning back the clock on my waistline. And I wasn’t exceptional that night. WABC Eyewitness News of New York conducted a poll that showed 46% of those surveyed said their New Year’s resolutions for 2005 involved dieting.

But my pain is usually someone else’s gain — and it might well be yours. Because one of the best-kept secrets for small-cap investors is that there are a handful of undervalued companies supplying supermarkets, health food stores and doctor’s offices with diet foods and weight-control programs. And they offer a great way for you to get phat.

As you can imagine, the U.S weight-loss market is huge (no pun intended). Here are few tasty figures to chew on, courtesy of Marketdata Enterprises…

Medically supervised diet programs, which rung up $2.12 billion in 2002, will increase to $2.44 billion by 2006 — up 15.1%. Retail and multilevel meal replacements and appetite suppressants will soar 47.9%, from $2.38 billion in 2002 to $3.52 billion by 2006. And diet soft drinks, which produced $14.86 billion in revenues in 2002, will grow 12.8%, to
$16.76 billion, in 2006.

But don’t jump to the obvious conclusion that the carb-starved minions of the Atkins and South Beach diets are dominating the market expansion. Recent data indicate that those trendy weight-loss regimens may have already peaked…leading an army of disenchanted dieters back to time-proven organizations like Weider Nutrition Intl., Medifast, Inc. and NutriSystem, Inc.

This may come as a surprise, but a study by the American Institute for Cancer Research showed that low-carb dieting ranked third behind the old-fashioned approaches of increasing produce and decreasing fat intake. In another study, independent market researcher NPD followed 11,000 low-carb fanatics in 2004 and discovered that by year-
end only 25% reported that they were still “significantly cutting carbs.” Meanwhile, of the 1,100 people interviewed by Opinion Dynamics Corp., between December 2003 and August 2004, 11-12% said they were on a low-carb program…that number shrinking to 8% by October 2004.

While that’s bad news for the Atkins estate, it’s great news for us, as more tubbies flock to our low-flying, small-cap trio of diet food providers.

When it comes to Weider, Medifast and NutriSystem, I think of them as polyester perennials…because like polyester clothes, they’re mass marketed and fad resistant — and they make their manufacturers (and shareholders) gazillions of dollars.

For example…

Weider sells about 50% of its beverages, snack bars and supplements through mass-market superstars Costco and Wal-Mart. While you won’t see Weider’s stock price seesaw like so many diet fads, its revenues have been consistently growing. Let’s look at the most recent earnings…

For the second quarter of 2005, Weider’s net sales were $67 million, up a commendable 10.2% from the same period last year. And commensurate net income was $3.5 million, versus $2.7 million — an impressive increase of 29.6%. For the six months ended Nov. 30, 2004, net sales came in at $136.7 million, compared to $124.4 million the same fiscal period of 2004 — or a respectable rise of 9.9%. For the first six months of fiscal 2005, Weider reported a net income of $7.2 million, compared to $4.9 million for the comparable six-month period in 2004 — an incredible improvement of 46.9%.

With these kinds of numbers, you’d think that Weider’s stock price would be shooting the moon. But if you look at its 52-week performance, it’s down 0.22%. That’s the bargain basement, where you have to dig through heaps of polyester “fashions” to find the real gems, including…30-year-old NutriSystem.

NutriSystem supplies its customers with online and phone counseling that supports meal programs delivered to the doorstep. The company has a distribution/sales deal with QVC, whose reach is some 86 million American homes, 13.1 million households in the United Kingdom, 34 million homes in Germany and more than 11.6 million homes in Japan. That’s a lot of couch potatoes.

The most recent financial report to come from NutriSystem was dated Feb. 1., when it issued a press release for its first-quarter 2005 outlook in anticipation of Feb. 23 earnings.Gazing into its crystal ball, the company expects a 100% revenue increase year over year. If that’s the case, we’re looking in the neighborhood of $26 million, up from first quarter 2004′s $13.2 million (which represents an 85.9% increase from the first quarter of 2003).

Let’s review NutriSystem’s most recent full reporting period, the third quarter of 2004. Revenues hit $7.6 million, a 58.3% surge from the $4.8 million recorded in the same period of 2003. Unfortunately, net income didn’t seem to stack up: For 2004, the third quarter netted a paltry $121,000, versus a net loss of $225,000 for the same period in 2003. True, that is a 153.8% jump. But it also shows that the company is spending a fortune on marketing and customer acquisition to gain mind share from the media’s low-carb blitz.

With a 52-week stock pop of 141%, NutriSystem could still be considered a deal as it currently hovers under $6. For bargain hunters, driving the top line without a corresponding upturn in the bottom line could leave this stock dragging for a while…like a pair of polyester slacks in need of a big hem.

If we keep digging into the bargain-basement heap, we’ll eventually find 50-year-old Medifast. With a 52-week stock drop of 63.2%, it may reek a bit, despite some high-quality features.

Medifast’s beverages, snacks and soups augment a balanced diet of home cooking fare. The program is sold through 15,000 physicians, Medifast weight loss centers and the company’s Web site. Despite an affiliation with Johns Hopkins University, things started to unravel quickly at Medifast — much like pulling a thread on a cheap polyester sweater.

Given the herd mentality of Wall Street, it was Seidler Companies’ analyst David Block who led the stampede on Medifast’s big sell-off. When Block initiated coverage of Medifast on Oct. 1, 2003, he had opened with a “strong buy,” targeting $18 on the day that the stock closed at $11.60 — meaning that he expected the stock to eventually turn a profit of 55.2%.  The stock fulfilled Block’s projection on Nov. 6, hitting a high of $18.75 and closing that day at $18.49.

After that, as Medifast consistently missed earnings, Block hammered the stock…going from a “hold” on March 16, 2004 to his first “sell,” on Aug. 17, 2004. Generally, Medifast was increasing top-line revenues while net income was dramatically deteriorating. Estimates to the analysts kept dropping. Essentially, Medifast was spending millions on TV advertising, but Wall Street wasn’t impressed with the results.

The big problem was that Medifast was completely swamped by the enormous response to its ad campaigns and couldn’t follow through on all the leads — losing millions in potential sales.

Looking back at Block’s first “hold” rating, it coincided with Medifast’s fourth-quarter 2003 report, in which revenues surged to $6.7 million, from $3 million during the same period of 2002 — up 123.3%. Reading down the company’s 10Q statement, things get ugly. Net income dropped to $520,000 in fourth quarter 2003, from $1.54 million in the
same quarter of 2002 — a tumble of 66.2%.

The stock closed at $3.33 on Feb. 14, 2005, due to poor execution. Still, with a world-class manufacturing facility, a switch from TV to direct marketing and a huge customer base, Medifast has lots going for it.

I wish that I could shed as much weight as Medifast has value. Since the beginning of the year, I’ve lost about 5 1/2 pounds. I’ve given up my morning muffin and cut back portion sizes (except the booze). My approach, though, is to take the long view and lose 10-15 pounds over the course of the year. And when it comes to Weider, NutriSystem and Medifast, you may want to consider the long view as well.

Happy investing,

Irwin Greenstein

February 15, 2005

Get Phat on Diet Small Caps was originally featured in the Penny Sleuth.