News Analysis date published New: 
Friday, July 16, 2010 - 15:08
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Thursday, August 15, 2013 - 04:51
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Friday, July 16, 2010 - 15:08

The Best Idea of the Week

Friday, July 16, 2010 - 3:08pm

The trading week began on a bullish note, as Intel (Nasdaq: INTC) weighed in with a great quarterly report on Monday. But by week's end, stocks were slumping after a pair of downbeat reports from Citigroup (NYSE: C) and Bank of America (NYSE: BAC). Stocks are also feeling the pressure of a stressed consumer: A monthly survey of consumer sentiment conducted by the University of Michigan posted its lowest reading in 11 months.

In a market like this, it pays to be very selective, as we're in what's known as a "stock picker's market." The major indices may gyrate, but certain individual names can flourish. So it helps to take a look back and point the spotlight once more on the most compelling stock from this week's StreetAuthority winners and losers.

Leapfrog Enterprises (NYSE: LF)

Whenever a company badly stumbles, it needs a heroic sustained turnaround effort to win back the hearts and minds of investors. Just such a turnaround appears to be taking shape for Leapfrog (NYSE: LF), which remains in the investor doghouse, but is getting healthier by the quarter.

Earlier this week, we noted a stock-boosting upgrade from Needham & Co., which pushed shares of this educational toy maker up +18% on Monday. But the gains didn't hold, and the stock finished the week with a three-day losing streak.

The Fise, Fall, and Rise

Roughly a decade ago, Leapfrog was the hottest name in the children's toy space, thanks to a line of products called LeapPad, a tabular reading software platform that allowed children to read along syllable by syllable. The product was an instant smash, quickly selling millions of units. Word of mouth among moms proved at least as important as advertising.

Sales grew +96% in 2001, even as the broader U.S. economy was mired in a post dot-com funk. By 2002, a broadened product line that targeted kids from pre-school to junior high helped push the sales needle yet higher, as a +69% revenue spike pushed annual sales above the $500 million mark.

Even though sales would go on to rise another +27% in 2003, with earnings per share passing the $1 mark, a line of me-too products from Mattel's (NYSE: MAT) Fisher-Price division began to steal Leapfrog's thunder. Almost overnight, retailers stopped giving Leapfrog premium end-of-the-aisle shelf space, parents started to think of the company's products as passé, and the company entered into a long decline. From 2003 to 2009, sales fell by more than -40%, and shares, which were once richly-valued, lost more than -95% of their value.

To regain the lost mojo, Leapfrog rolled out a wide range of new products, many of which were met with critical favor but consumer apathy. For example, in early 2005 the company introduced FLY, a pen-based computing platform aimed at "tweens" and young teenagers. Leapfrog executives hoped it would signal not only a new platform to replace older ones, but that it would finally crack the elusive market of older-aged kids who had been "graduating" from LeapFrog products. Despite strong retailer support, and a "Toy of The Year" award in February 2006, the FLY proved to be a disappointment.

But even though Leapfrog would go on to post four straight unprofitable years through 2009, the seeds of a turnaround appeared in 2008 when the company introduced Tag, a pen-based computer system that can upload and download information. That summer, management also rolled out three new product lines, including an upgraded version of the original LeapPad. But the economic slowdown led subsequent quarters to disappoint, and shares moved below $2 in the spring of 2009.

Christmas Cheer

But just as Leapfrog moved even further from investors' radars, business finally started turning around this past holiday season. Those products released back in 2008 were slow to gain traction, but were finally finding appeal with consumers. In February 2010, the company announced that it had earned $0.46 a share in the fourth quarter of 2009, 50% higher than consensus estimates, on a +27% jump in sales.

Sales rose an even more robust +42% in the first quarter of 2010, thanks to significant growth in the interactive toys segment. Instead of seeing another year of sales declines, analysts have started to talk about meaningful sales growth in 2010 and 2011. And after losing gobs of money during the past four years, Leapfrog now looks poised for profits in 2010, and far higher profits at that.

Action to Take --> Earlier this week, Leapfrog's shares surged above $5 as analysts at Needham & Co. raised their rating to "strong buy," with an $8 price target after channel checks showed that second-quarter sales should also be quite robust. Shares have since drifted back below $5, but have a good chance of reaching that price target if this string of quarterly results can be sustained.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.