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NutriSystem (NTRI) has become the newest addition to the Ambitious Investor portfolio. The company reports earnings on Tuesday afternoon, and presents excellent risk/reward characteristics that make it a compelling purchase ahead of the announcement. Our reasons are outlined below:

1. Consensus estimates by analysts have been revised down significantly over the past couple of months, indicating that the street feels the company will fall short of their guidance/targets. This means expectations are extremely low for the company, thereby making it easier to surprise to the upside.

2. NTRI already forecasted a revenue drop of 20% into their guidance from the previous quarter. The company has clearly set the bar low, which made for a big pay days for the shorts sellers who were in the stock a few months ago. However, given that this quarter represents the "New Years Resolution" season, we believe it is unlikely that we will see such a sharp drops in their revenue from the "pre-holiday" quarter.

3. Short interest is 71%!!!! That means that any slight beat in their report will trigger a massive short squeeze. And even if they miss, is the short interest actually going to spike to 90%? Doubtful. And is the small remainder of investors who are holding the stock long, going to sell at a 52 week low when they have already ridden the stock down this far? Again, doubtful. Therefore, the selling pressure on the stock should be fairly limited.

4. NTRI is only trading at 7 times earnings. That is not only a historically and extremely low valuation for the company, but it is significantly lower that its competitors. WTW and HFL for example both trade at nearly 20 times earnings. Plus WTW also reported solid earnings on Thursday night, and the stock took off. It could be an indication that the industry is in good shape.

5. Revenue over the last year was just under 800 million. The company's current market cap is 800 million. That means it is trading at only 1 times sales! The rest of the industry trades at more than twice sales. Again, this is another indication that it is deeply undervalued.

6. On the day the stock collapsed back in October, we saw huge institutional buying from the likes of Citigroup and a number of large hedge funds. The average price they acquired the stock at was likely between 30-34. Although this is not an absolute indicator for the undervalued nature of the company, it certainly aids the argument.

7. Just in the last few months, the company has dramatically expanded its product line to appeal to a broader group of people. Before, their primary product was Nutrisystem Nourish, which was marketed to a broad and general group, but lacked appeal to the male and elderly demographics. Now, they have introduced lines that separately target Men and older individuals as well, which should be reflected in this upcoming report.

8. One of the things that hurt NTRI in the past quarter was that, although revenues were solid, their net income was much lower due to higher customer acquisition and retention costs. A part of that can be due to the large celebrity endorsements they had to pay for (Dan Marino, Don Shula). Although some of those expenses will be continue to be present, the large bulk of these up-front costs have already been paid out, and therefore will have less of an impact on the current quarter.

9. There has been recent speculation surrounding a possible acquisition of the company. Although this does not support an argument to buy the stock ahead of the report, this speculation should provide a solid buffer to the downside should they in fact disappoint.

Bottom line: Even if the company misses estimates, there is minimal downside risk based on the factors listed above. However, should they surprise Wall Street, the upside potential is massive, and could catapult the stock north of 40 from its current level of 23 making for an excellent risk/reward opportunity.

Disclosure: long NTRI

Source: NutriSystem Looks Sweet Heading Into Earnings