It's one thing for shares of a microcap company to surge (or decline) 20, 30, 40% in one day since trading in smaller companies is often illiquid, catalyst driven, and can have a mind of its own. But, it's quite another thing for a mid- or large cap company to see such extreme share price moves in a single day.
However, today, Weight Watchers International (WTW) surged by 46% to $65 per share on the back of favorable 4Q10 results and an earnings forecast that blew Wall Street consensus (and our) 2011 estimates out of the water: the company guided to $3.50 - $3.85 per diluted share versus a consensus estimate of $2.77:
Commentary from Weight Watchers' press release:
"I am gratified that we were able to deliver full year 2010 EPS of $2.56 per fully diluted share, above the original 2010 earnings guidance range we provided at this time last year," commented David Kirchhoff, President and Chief Executive Officer of the Company.
"Looking at 2011," added Kirchhoff, "we are seeing terrific enrollment volumes in our North American and UK meeting businesses and further strengthening in our WeightWatchers.com business. We are providing a 2011 earnings guidance range of between $3.50 and $3.85 per fully diluted share."
AGAIN, rarely does such a move happen for such a large company ($3+ billion market cap prior to move). We've really only seen such a move as a result of M&A activity, sometimes via unexpected, hostile takeover bids that -- at least from the Market's perspective -- seem to come from left field.
What happened? The company's very positive surprise brought an extreme positive revaluation from the Market. The Market now sees that, not only is the "coast clear" from a fundamental standpoint, but the business model's operating leverage is substantial and was -- to this point -- largely unappreciated. Amidst a massive upward earnings revision, more people can immediately see the positive WTW thesis we've been talking about since late 2009: Weight Watchers owns and operates high-quality, high-margin, high-ROIC business model with a powerful, difficult-to-replicate franchise.
Why such a gigantic move? We generally believe a 20 times price-to-current-earnings multiple (5% earnings yield) is fair for high quality businesses. With near-term earnings power now approximately one dollar above expectations, the Market suddenly sees an additional $20 of upside (at a 20 times multiple) and, amazingly, awarded this amount today.
What's the fair value now? In our most recent WTW discussion, Just Like Clockwork, we pegged Weight Watchers' fair value in the $40-50 range, unaware that we would see such tremendous operating leverage in 2011. If earnings power is now $3.68 (midpoint of range), 20-times this figure brings us to a fair value of $74 (*based only on a P/E valuation; overall, we prefer a composite valuation approach). Of course, in four to five months' time, the Market will begin looking to 2012. We've not had time to review our model, yet if fundamentals remain solid this year, 2012 estimates might reasonably be $4.00 per share, implying an $80 fair value at a 20 P/E (still below historic multiples awarded to the company).
Wow. What a stunning revaluation on the back of solid execution and results by Weight Watchers. Now, those who were negative or cautious on the name will likely now change their tune. Yet, although we see incremental upside and potential for dividend hikes over the medium-term -- to risk stating the obvious -- the best time to buy WTW was long before today's feeding frenzy.
We can reiterate a recurring theme shared in our January "Clockwork" post: history indicates that the greatest returns are generated by swimming against the tide and accumulating ownership stakes when everyone else is running scared. Of course, normal human psychology makes the mental decisions to purchase out-of-favor companies inherently difficult.
How best to beat demons of the mind during those periods and increase the odds of handsomely outperforming the Market over time? Remove emotion from the process through a disciplined, rational research and valuation framework.
Disclosure: long BIDZ, WTW.
© 2011 Jeffrey Walkenhorst
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