Toymaker Stocks Are Not Child's Play

There was a lot of groaning about toy manufacturers this week when a couple of toymakers missed the mark in their earnings reports. After such a successful holiday retail season, investors were shocked to see key players in the industry fall short. That, and the stalled IPO of Toys R Us -- still two years in the making -- has some investors convinced that the toymakers stocks are a bad play.

However, they're not taking into account that the retail marketplace is still ruled by tightfisted consumers, putting the screws on retailers, who are passing on the pain to their suppliers. But relief is on the way, as the economy improves.

Parents always spend on kids, whether the GDP rises or falls. And toys are not really commodities; kids want the brand-name toys the big manufacturers make, not generic imitations, so prices are a little less elastic than in areas like apparel. Try giving a little girl one of those cheap Barbie clones and see where it gets you.

The toy market is an interesting one. The annual Toy Fair is held in February because the buyers are making decisions now, well in advance of Black Friday. So retailers are buying stock based on an economy not quite fully recovered, which means lower sales for the manufacturers now. But if the economy comes in stronger in the summer, the manufacturers could sell more, and unexpectedly higher sales could mean upside earnings surprises later in the year.

So let's ponder the opportunities to pick up some blue chip toy brands while their stocks are getting some short-term punishment. Mattel (NAS: MAT) reported profits short of expectations, blaming "cautious retailer orders," and its stock took a 9.4% hit for its troubles. Mattel, with a P/E just under 15, has a four-star CAPS rating; though the $35.8 target price of most analysts is close to the current share price, as I mentioned earlier, the company could benefit from outsize ordering later in the year if the economy picks up.

Things got uglier for Jakks Pacific (NAS: JAKK) , which reported a first-quarter loss of $0.62 a share, up from $0.39 last year. Now it's facing an increasingly hostile offer from shareholder Oaktree Capital, which offered $20 a share last fall and got turned down; apparently Oaktree made another offer in anticipation of the weak results and got turned down flat again. That's good news for the stock, which has gone up thanks to the speculation, but with those results and a P/E nearing 56, I'd stay away from this play date.

(NAS: HAS) , on the other hand, has a P/E just under 13, and as Fool Sean Williams has pointed out, it's grown earnings 11 years in a row and dividends have gone up tenfold over the last seven. And Hasbro makes Transformers, My Little Pony, Battleship, and practically every toy that's been turned into a movie in recent memory.

That's the real killer advantage these companies have to offer: brands. Big-name brands. Mattel has Barbie, Hot Wheels, and too many others to count; Jakks makes Smurfs, Hello Kitty, and Pokemon toys under license.

That's half the battle in the toy business: According to consultants USA Toy Experts, kids' wishes are the No. 1 influence when parents shop for toys. Once you have the toys kids want, you just have to get the parents to give in. And that's the tricky half of the battle, because price competition is fierce, especially since the recession retrained consumers to bargain hunt.

This is the time of year when retailers are making stocking decisions for holiday 2012, and the economy is still iffy. But like most manufacturers, toymakers are trying to speed up the supply chain to give retailers more flexibility, like when they had to crank out more Zhu Zhu Pets to meet demand a couple of Christmases ago. So the retailers could boost orders later in the year, if the economy supports it.

As any retailer will tell you, spending on the children is the last thing households cut back on in hard times. Parents may spend less, but they will still put toys under the tree. And as the economy recovers, Mom and Dad will open their wallets more.

So this could be the moment to buy toymakers, when their stocks are getting punished. But investors need to be willing to hold on to the stock at least until the holidays, to see if the scenario pans out. Either way, toymakers are a serious investment in good times and bad.

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At the time thisarticle was published Mercedes Cardona does not own shares in any of the companies mentioned in this article. Follow her onTwitterand on herwebsite.Motley Fool newsletter serviceshave recommended buying shares of Hasbro and Mattel.Motley Fool newsletter serviceshave recommended creating a bear put spread position in Mattel. The Motley Fool has adisclosure policy.We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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