If you haven't heard by now, we're celebrating The Motley Fool's 10th anniversary this month. In between the daily entertainment here at HQ (clowns making balloon animals, roving soda jerks dispensing root beer floats... that sort of stuff), I've been thinking back about what attracted me to the Fool in the first place.

One of my favorite features was, and still is, the Foolish 8 stock screen, which each month provides an interesting list of companies for further research. It's still available inside each edition of Tom Gardner's Hidden Gems.

A company that caught my eye this month is Medifast (AMEX:MED), a maker of weight-management and meal-replacement products whose stock price has soared over 700% in the past year. I thought it deserved a closer look.

Foolish 8 criteria
Here's a quick review of the eight (see how well that worked out?) Foolish 8 criteria, along with Medifast's numbers in parentheses:

  1. Revenues: $500 million or less ($16.9 million for trailing 12 months)
  2. Earnings and sales growth: 25% or greater (333% earnings, 146% sales growth)
  3. Net profit margin: 7% or greater (18.3%)
  4. Daily dollar volume: $1 million to $25 million ($5.07 million)
  5. Insider holdings: 10% or greater (40%)
  6. Share price: $7 or greater ($13.90)
  7. Relative strength: 90 or greater (100)
  8. Operating cash flow: a positive number (+$3 million TTM)

Only seven companies passed the screen this month. Most interesting is the fact that Medifast is one of two dietary products companies on the list; the other is Usana Health Science (NASDAQ:USNA), a multilevel marketing firm that distributes nutritional and personal-care items, as well as meal-replacement products. Though Medifast and Usana are very different companies, their simultaneous appearance on the F8 screen says something about Americans' willingness to pay for weight-loss products and programs.

We'll get back to Medifast's numbers in a moment, but, first, a look at what the company sells and how it sells it.

The business
Medifast's management is straightforward about its mission of becoming "a leader in the field of medically supervised nutrition, disease and weight management, and health-related nutrition programs." It has three channels of distribution:

  1. The Medifast Lifestyles Program, which is a network of doctors and health-care professionals who support patients on the Medifast weight-loss program. Management estimates 15,000 physicians have used the program since 1980. Medifast also provides medical practitioners via telephone or email for customers without a participating physician.

  2. Take Shape for Life, a wholly owned subsidiary that provides 16-week "virtual clinics." The clinics are implemented by "advisors," who recruit entrants and provide them with guidance and product samples. This is similar to multilevel or network marketing.

  3. Traditional physicians, who carry the product line and implement Medifast programs on their own.

The market
The company serves a rather large market (pun intended). The World Health Organization says that some 16% of the earth's population, or about 1 billion people, is overweight. According to the American Obesity Association, 44% of Americans are carrying too much fat. That number includes the 21% considered obese and 3% severely obese.

Medifast's main competition in the meal-replacement business is Unilever's (NYSE:UL) SlimFast Foods. Medifast management estimates SlimFast's retail sales to be in excess of $750 million annually, which dwarfs Medifast's $17 million figure. Other competition comes from Weight Watchers (NYSE:WTW) and Jenny Craig, both of which sell prepackaged meals.

In an effort to break through the dominance of the aforementioned giants, Medifast is dramatically increasing its advertising budget this year. In a curious choice for a spokesman, the company has tabbed sportscaster Dick Vitale as the point man for its "Medifast is Awesome Baby!" marketing campaign. (No word yet if Vitale's penchant for making Americans lose their appetite is cannibalizing sales.)

The numbers
Once past the F8 screen, the first thing I look at is how much, if any, free cash flow a company is generating. Medifast produced $2.5 million in cash from operations in 2002, but its $4.5 million in capital expenditures knocked free cash flow into negative territory. Most of the capex came from the $3.4 million purchase of a manufacturing plant in July. Since it has plenty of excess capacity, we shouldn't be seeing this kind of outlay every year.

Indeed, the company had virtually no capital expenditures the prior year. If earnings growth continues at a strong pace, Medifast will return to cash-flow positive sooner rather than later.

Though we're not yet able to glean a meaningful price-to-free cash flow ratio, we do know the stock is trading at 40 times trailing-12-month earnings and about 34 times estimated 2003 earnings. Beyond the fact that management has projected 2003 growth in the range of 25% to 50%, we have very little to compare that to. (Third-quarter earnings will come out tomorrow, so perhaps we'll learn more then.)

This is a lightly followed company, and the few earnings estimates I found varied too widely to be of much use. This is a good thing, however. Light coverage, combined with low daily dollar volume, can give a leg up to the thorough researcher who accurately nails down a company's future performance.

That's the essence of Foolish 8 investing.

If you have some insights on Medifast or the weight-loss industry, feel free to post them on our Foolish 8 discussion board!

Rex Moore has never met a meal he didn't like. At press time, he owned no companies mentioned in this column. Here's what he does own, and here's the Fool's disclosure policy.