Less than a month after topping Fortune Magazine’s list of the 100 fastest-growing companies, Nutri-System, Inc.’s (NTRI) growth rate came to a screeching halt. The company announced yesterday that while revenue growth will top 20% in the third quarter it will be well below expectations, and earnings per share are expected to be between $0.62 and $0.66 – barely budging from $0.63 last year and well below the $0.82 consensus. With the shares selling off more than 20% in after-hours trading, investors have to figure out whether this stock’s weight loss is permanent or whether, like many of its customers, it could be on a yo-yo.

To start out with, I’m going to lay my cards on the table and admit I didn’t see this coming. I thought investors were being a bit irrational when they sold the shares following a strong earnings report and slightly weak guidance (that has now been revised to really weak.) So when considering anything I say about the name, remember that I have been dead wrong about it to date.

That said, with the after hours sell-off the stock is now trading at just over 10x the trailing 12-month free cash flow. From that multiple, I feel like I can earn an adequate return even if the company doesn’t grow – all it needs to do is maintain its current levels of cash flow.

The problem is, the aforementioned growth has taken the cash flow off the charts. For example, if the growth had been steady I might feel that free cash flow could retract to the $60 million the company posted in 2006, rather than the $108 million it gained in the last half of that year and the first half of 2007. While that would be a sharp cutback, the free cash flow yield would still offer support from which I would hope for growth.

But what if cash flow dropped to 2005 levels? It is surely possible that Nutri-system, a company more than 30 years old, could drop back to the levels seen two years ago, is it not? Well, if it is possible it would be a big problem. In 2005 Nutri-System’s free cash flow was only $12 million. Next to nothing. And I don’t even want to think about 2004.

So, from my point of view Nutri-System doesn’t qualify as a sound investment opportunity right now, despite an apparently cheap valuation. It might, however, be worth a trade.

One guy who did get this story right was Citigroup’s Gregory Badishkanian, who warned last month that sales may suffer in the short term as dieters try out GlaxoSmithKline’s (GSK) new over the counter weight loss drug Alli. He also noted that the comparisons to last year’s third quarter are difficult as that is when Dan Marino joined the company as spokesman. And, of course, October is not known as the time to start a diet.

The tough comparisons are likely to continue, but Badishkanian doesn’t expect dieters to enjoy the digestive side-effects of taking Alli for very long. After we gorge ourselves this holiday season, we are likely to make the same New Year’s resolutions we have often made in the past. And in each of the last three years Nutri-System has enjoyed a strong rally from January through April.

Personally I feel like I would benefit more from the product than from the stock at this point. If the shares are still down in late December I may even attempt the seasonal trade, and by the time that is done there may be a little more clarity about the sustainability of free cash flow.

In any case, making the resolution play will require a good deal of resolve for this volatile stock.

Last 5 posts by William Trent

• Capacity Utilization - August 16th, 2009
• Corporate Profits - July 12th, 2009
• Capacity Utilization - April 18th, 2009
• Another Record: Capacity Utilization - April 2nd, 2009
• Record Territory - March 27th, 2009