Shares of Weight Watchers International (ticker: WTW) skyrocketed on Wednesday, thanks to a couple of impressive tailwinds. First, there was a nationally televised appearance by major shareholder and lifestyle icon Oprah Winfrey, who claimed Tuesday night that the service helped her shed 42.5 pounds.
Then the Weight Watchers plan was named the No. 4 best diet overall by U.S. News & World Report in a list of rankings that came out Wednesday morning. WTW stock jumped 20 percent in Wednesday trading following the reports.
That leaves investors to ponder the question: Does the inflated price of WTW stock represent lean muscle or is it just water weight? For a long-term investor, does WTW stock and Winfrey’s ringing endorsement add up to good value in the company that produces the popular diet plan?
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While Weight Watchers shares don’t look unforgivably bloated after Wednesday’s run-up, there are more than a few reasons to be skeptical of shares. You shouldn’t buy WTW on a one-day rally, just as you shouldn’t devour a Bloomin’ Onion just because it’s cheat day.
“This appears to be irrational exuberance by the market,” says Robert Johnson, president and CEO of The American College of Financial Services. “Investors are motivated by fear and greed , and it appears that greed is ruling the day with Weight Watchers stock.”
Aside from the likelihood that this rally was caused by irrational exuberance, here are three additional reasons to take WTW’s sudden gains with a grain of salt:
Reason #1: Oprah is talking her book. Before buying Weight Watchers stock on the strength of Oprah Winfrey’s impressive weight loss, know that Winfrey is a massive shareholder in WTW stock. In October 2015, she bought a 10 percent stake in the weight management company after Weight Watchers approached her about a potential partnership. Since then, she has been appearing in company commercials and was also given a board seat.
Not only does Winfrey have an extreme financial incentive to lose weight and flaunt it publicly, but WTW stock has spiked before on Oprah-related news. After she announced her 10 percent investment in October 2015, shares more than tripled, going from about $7 a share to more than $26 a share in a matter of weeks.
The majority of those gains proved illusory though, as shares fell to the $11 level by February. If you’re considering WTW stock after the latest Oprah bump, remember that the profits can come quick and go just as quickly.
[Read: 7 Technical Signs to Spot a Market Rally.]
Reason #2: The business isn’t thriving. While point No. 1 should be compelling enough to give most investors pause, point No. 2 is arguably more disconcerting: Weight Watchers, even after world-famous, trimmed-down Winfrey began appearing in company ads, has been treading water from an operational standpoint.
Total revenue in the third quarter of 2016 was up less than 3 percent from the year before, which should be a red flag for potential WTW investors. Remember, a year before, Winfrey had nothing to do with Weight Watchers. Twelve months later, after her name has been inexorably attached to the brand and this experiment has been given time to play out, there is almost no difference in the top line.
If you were looking for a reason to buy WTW, you might point out that earnings were up about 40 percent from last year, which is true. But they were achieved by trimming down provisions for income taxes; in other words, earnings rose largely due to accounting and not improved business prospects.
“While Oprah is certainly a cultural icon, I can’t imagine that her weight loss will translate into dramatically improved earnings by the company,” Johnson says.
Reason #3: The 20 percent jump looks like a classic “short squeeze.” The most recent available data on short interest — or the amount of people on Wall Street betting against a stock going up — show WTW as a short-seller’s favorite. A full 26.8 percent of Weight Watchers shares were sold short as of Dec. 15, making it one of the 50 most-shorted names on the New York Stock Exchange.
High short interest combined with sudden, brief rallies in a stock’s price often point to a “short squeeze,” which means the rally was fueled by shorts rushing to buy back the stock, cover their position and exit the trade. From a retail investor’s perspective, this means that much of the demand for the stock was artificial and that the rally didn’t truly illustrate investors’ belief in the company’s future good fortune.
Already on Thursday, WTW stock was shedding its excess baggage, as shares dropped more than 7 percent.
Lose pounds, not dollars. Weight Watchers is not a bad company. It’s profitable, cash flow-positive, and its services are generally well-regarded. The Weight Watchers diet is one of the best around. WTW stock trades at less than 12 times earnings.
The problem with putting too much stock in WTW’s sudden rise — aside from the three glaring ones mentioned above — is the business doesn’t seem to have a huge runway for growth. If the almighty Oprah hasn’t been able to stoke meaningful growth at the company, it’s fair to ask what will.
Companies like NutriSystem ( NTRI) will always be there, competing. It’s an industry with virtually no barriers to entry, and nowadays even companies like Fitbit ( FIT) and Apple ( AAPL) can loosely be considered competition.
[Read: 5 Reasons Donald Trump’s Presidency Will Include a Recession.]
A new year is upon us, and it’s true that people will be seasonally obsessed with getting in shape. But don’t lose your shirt while trying to bet on other people losing weight. There are countless opportunities for investors in the stock market, and WTW isn’t close to being one of the best stocks to buy for 2017.
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3 Reasons the 20 Percent Weight Watchers (WTW) Stock Rally Shouldn’t Last originally appeared on usnews.com
