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Lesson Learned: Jakks Pacific (JAKK)

February 16, 2010 | About:


As is usually the case, we often learn a great deal more from our investing mistakes as we do from our successes. This was my experience for a small cap toy company Jakks Pacific (JAKK). I’ve put together some bullet points as to why purchase was made and went wrong. If one invests for a long enough period, one will certainly make mistakes. The key is building on lessons learned from those mistakes and containing the damage.

As value investors we are constantly on guard for the infamous value trap. It follows that it’s incredibly important to understand why an investment is cheap. Many of the standard value metrics such as price to book need to be analyzed and cross referenced with multiple inputs. For example, JAKK would most likely pop up on many value screens as being cheap on the surface. However, upon breaking down the components of the company’s net worth, it is clear that 50% of shareholders equity consisted of goodwill and other intangibles – a potential red flag. While it may seem that many of these points are obvious and simple, it is amazing how easily they can fall into our blind spots.

Brief Description:

JAKKS Pacific, Inc. (JAKK) is a multi-line, multi-brand toy company that designs, produces and markets toys and related products, writing instruments and related products, pet toys, treats and related products and other consumer products. The Company focuses its business on acquiring or licensing trademarks and brand names with long product histories (evergreen brands). JAKKS products are toys and accessories that include traditional toys; craft, activity and writing products and pet products. The Company sells its products to toy and retail chain stores, department stores, office supply stores, drug and grocery store chains, club stores, toy specialty stores and wholesalers.

Financials:

Revenue – 10 year revenue grew at annualized rate of 17%

EBIT – 10 year EBIT grew at annualized rate of 12.5%

Book Value – 10 year book value grew at annualized rate of 9%

Buy Rationale:

- Deep value with strong balance sheet.

- Positive cash flow with minimal capital expenditures

- Profitable licensing model



Red Flags:

- EBIT and book value failing to keep pace with revenue growth.

- Balance sheet heavy on intangibles.

- No economic wealth created – low returns on capital.

- Multiple pending legal issues.

- Hefty insider option issuance and selling.



Lesson Learned:

- Formulate an investment thesis beyond pure valuation.

- Cheap does not equal value.

- Cheap does not equal safe.

- Focus on tangible net worth.

- Ongoing legal battles only benefit attorneys.



It is always possible that I may suffer from impatience and the investment may work out over time. Could JAKK still be a winner? Absolutely – it’s cheaper now than when I first invested, but if a potential investment doesn’t fit to your own process, it shouldn’t qualify for use of your capital. A simple way to avoid these pitfalls is to create a checklist specific to your own process with each potential investment decision.

About the author:

William J. DeRosa, Jr., CFA
William J. DeRosa, Jr. is the General Partner of Anthem Asset Management, LLC is an independent investment management company. He has also served as Director of Equity Research and Senior Portfolio Manager at various buy-side asset management firms. Mr. DeRosa is a Chartered Financial Analyst and is a member of The CFA Institute.

Rating: 4.6/5 (17 votes)

Comments

batbeer2
Batbeer2 premium member - 4 years ago


Revenue – 10 year revenue grew at annualized rate of 17%

EBIT – 10 year EBIT grew at annualized rate of 12.5%

Book Value – 10 year book value grew at annualized rate of 9%


It occurs to me these are all trends. A value trap by the way is also a concept based on a perceived trend. Graham tells investors to analyse the source of income and determine that it is stable. This IMHO is not the same as trend analysis.

Trends are simply incompatible with the concept of a margin of safety.
go_loe
Go_loe - 4 years ago


It always comes down to what is the price that you pay for an asset/business..What kind of returns that you expect from the asset/business. Even a poor asset/business is attractive at some price. you also talk about the tangible book value as a back up which is correct..If you think about that now, the price that you pay today($12) is not crazy for a successfully operating business(throwing of free cash flow) for years.

Cash on hand - 154 M

Total Current assets - 610M

Tangible Book value - 635M (610+25(PPE))

Total liab - 315 M(no long term dept)

Net Net = ~300M

Free cash flow geneation = 40M -100M in last 5 yrs

The price you pay today is 330M.

By conservative estimates of earning generation/free cash flow as a ongoing business, it definitely worth more than 330M for a rational business owner. Plus they are not capital intensive business, so the cash is not going to evaporate tomorrow.

So based on the facts today, this is not bad asset to own at these prices.
buffetteer17
Buffetteer17 premium member - 4 years ago
I will continue glumly holding my JAKK shares from 2007, currently down 41% from my purchase price. It gripes me how well paid management is. But the value looks extreme, and the free cash flow is still holding up reasonably well.
batbeer2
Batbeer2 premium member - 4 years ago
I will continue glumly holding my JAKK shares from 2007, currently down 41% from my purchase price.

Congratulations with your determination.... you may want to sell and rebuy them just so it looks better going forward ;-) I noticed your fair value estimate from 2007 and I more or less agree.
DaveinHackensack
DaveinHackensack - 4 years ago
It's interesting how we are conditioned as value investors to tolerate large declines like a 41% drop. I've started to rethink that, partly due to the experience of shorting. I mentioned in a recent comment my aim to limit losses on short positions to single digits, and recently I started to apply similar thinking to some long positions. Not that declines equal losses, or that I would try to limit declines on long positions to single digits, necessarily, but I applied stop limit orders to most of my long positions recently (adjusting the stops based, roughly, on the volatility of the respective stocks) and consequently unloaded some of those positions recently. Now I'm down to holding 11 different stocks.

The two long positions I am most bullish on I won't do this with (though I have quasi-hedged one of them, as I mentioned here recently).
go_loe
Go_loe - 4 years ago
Its easier to place/advice limit loss orders..That takes away the most important aspect of investing, which is buying something cheap & hold it until the price meets the value that you perceive/ you made a mistake about the business value.

If you are down 41%, & if you also think the value that you thought is still intact, the most appropriate action is to do is buy more :-).

Limit losses trading - Sell something because the market price declined 10% below your purchase price irrespective of the underlying business value. It seems like you have absolutely no clue about what you are buying & what its worth. If thats what you call "Value Investing", good luck with that.
DaveinHackensack
DaveinHackensack - 4 years ago
If you are down 41%, & if you also think the value that you thought is still intact, the most appropriate action is to do is buy more :-).

I know the spiel. But you're jumping ahead to where you're already down 41%, and ignoring the part where you went from even to down 41% (where it will now take you a ~69% return just to get you back to even). Thinking your investment thesis was intact wouldn't necessarily stop you from selling when you were down, say, 15% or 20%, and then buying again when the stock had stopped dropping.



If thats what you call "Value Investing", good luck with that.

I call it having a sense of humility, and realizing that if the market's estimate of the value of a company is far off from my estimate, it's possible that I could be wrong. Bear in mind that my largest stock holding is one that I averaged down on after it had dropped 90% from my initial purchase price, so I've done my share of ignoring the market when I've had strong convictions in the past. The problem is that I've ignored the market with other picks in the past, and suffered permanent losses because of it.

I've also seen guru value investors ride stocks down to bankruptcy. Sometimes Mr. Market is right and you are wrong. You need a sense of humility to realize that, and you need to think beyond the dogma of long-only, un-hedged value investing to prepare for it.
go_loe
Go_loe - 4 years ago
"Thinking your investment thesis was intact wouldn't necessarily stop you from selling when you were "down, say, 15% or 20%, and then buying again when the stock had stopped dropping.[/font]"

what would you do if the stock declines 15% & jump back to your previous price or even more than what you paid for?? Assuming you have a default 10% stop loss order & buyback 20% below the earlier purchase?

This is something like market timing than investing, at least to me.

"I call it having a sense of humility, and realizing that if the market's estimate of the value of a company is far off from my estimate"

Market's value of company is far off from your estimate - That's the only way superior investments are created.
DaveinHackensack
DaveinHackensack - 4 years ago
what would you do if the stock declines 15% & jump back to your previous price or even more than what you paid for?? Assuming you have a default 10% stop loss order & buyback 20% below the earlier purchase?

First, I wouldn't have a "default" 10% stop loss order in this case. I think if you are going to use stop loss orders on long positions you shouldn't use a cookie cutter approach. But to address your hypothetical example, where the stock is gaping up and down in 15% increments, I probably wouldn't it buy it back in that case.

Market's value of company is far off from your estimate - That's the only way superior investments are created.

It depends on how far off. If you think you found a 50 cent dollar in a $10 stock, you might have a superior investment in the making. But if that stock drops to $1 after you bought it, you have to at least be open to the possibility that you might have bought a 50 cent nickel instead.
batbeer2
Batbeer2 premium member - 4 years ago
But if that stock drops to $1 after you bought it, you have to at least be open to the possibility that you might have bought a 50 cent nickel instead.

Fair enough, but if an investor is not capable of knowing what is a dollar and what is a nickel...

You buy a shop for a price equal to the cash in the register... then it burns down before you had a chance to empty the register.... You may be poorer but it was by no means a mistake. The pending fire was not knowable at the time.
batbeer2
Batbeer2 premium member - 4 years ago
(where it will now take you a ~69% return just to get you back to even).

It took me a while to figure out why that point was nagging me....

1) It doesn't take a 69% return to get back if you double down.

2) Switching to another stock, by itself, doesn't increase (or decrease) the chances of getting that 69% percent return.

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