Is Obagi Medical Products Great or What?

For every stock out there screaming "buy me," others simply give us a nudge and a nod. While all the attention might be focused on their five-star peers, we can sift through Motley Fool CAPS to find four-star stocks giving us the "high sign" that they're on the path to greatness. 

These opportunities -- including familiar names and beaten-down companies -- rank higher than most of the other 5,400 starred companies, and it pays to investigate their potential. This time out we'll take a look at specialty pharmaceutical Obagi Medical Products (Nasdaq: OMPI), perhaps a less obvious source for tomorrow's great buys.

Obagi Medical Products snapshot

Source: FinViz.com. N/A = not applicable; OMPI does not pay a dividend. TTM = trailing 12 months.

Of course, just because the 180,000-member CAPS community has chosen this stock as one being on the road to greatness doesn't necessarily mean you should buy in, too. Due diligence is still required, but let's see why they think it might merit your attention.

In the sight of greatness
Perhaps the biggest catalyst for Obagi Medical was that it was a buyout candidate. Earlier this year, analysts were speculating that some big name pharmas like Medicis Pharmaceuticals, Valeant Pharmaceuticals (NYSE: VRX), or Allergan (NYSE: AGN) would be the types of shops attracted to its beauty products "brand recognition," and the stock began an inexorable rise higher.

When shareholders expressed themselves in no uncertain terms they wanted the company sold -- they voted down a poison pill defense preventing someone from taking the company over -- it was high time that management hire an advisor to start exploring "strategic alternatives." Nothing doing. Last month, Obagi revealed in its conference call that it hadn't hired anyone, essentially dismissing investor wishes.

One big, happy family
Some large, institutional shareholders have been fairly vocal about management's entrenched mentality, with Voce Capital going so far as to say the board of directors needs to be "cleansed" of its myriad conflicts of interest. For example, Obagi routinely hires executives from Cobrek Pharmaceuticals to serve as "consultants" to Obagi. The president and CEO of Obagi also serves as CEO of Cobrek, and he owns more than 10% of its shares.

There's good reason why shareholders might want to get out. Last year, Obagi had to withdraw from the Texas market after concerns were raised about its hydroquinone, and now it faces similarly prickly problems in California. Obagi was able to just recently get back into Texas, but the pending inquiry in California and the amount of money it's spending on technology issues has investors worried it will break down again.

A clear picture of growth
Ostensibly lumped in with biotechs, Obagi should really be measured up against other personal care companies like Avon Products (NYSE: AVP), Estee Lauder, and even Procter & Gamble (NYSE: PG). On various metrics, like where it trades to its book value or based on its market multiple and how that stakes up to growth estimates, Obagi does come out on top. Even on one of my favorite valuation rations -- enterprise value to free cash flow -- the beauty products maker offers a very attractive 10x multiple.

However, management can go a long way in thwarting a good growth story, and though some investors may hope Obagi Medical turns into their own Bare Escentuals -- which was bought by Japanese cosmetics giant Shiseido for $1.7 billion a couple of years ago -- it looks more like it will be bogged down in executive ego.

Sales aren't exactly growing gangbusters, and with more concerns being raised about skin whitening products like those of Obagi's that contain hydroquinone, it's unlikely it will reach the heights against it recently hit. Moreover, pharmas that might otherwise be interested in Obagi might be turned off by its reliance on such products. Its Nu-Derm cream accounts for 50% of its sales.

On the scale of whether it's great or what, I think Obagi falls into the "or what" category, so I'm rating it to underperform the broad indexes on CAPS, but tell me in the comments box below whether you think Obagi Medical Products can turn the other cheek and rebound from these doubts.

A great opportunity for you
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