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, Financial). 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.
