For the record, I've never believed that great companies make for great stocks, and I've never believed that fundamentals are the only thing that matters to investors. On the other hand, I'd never deny that sometimes, investors collectively (and completely) miss the boat. Enter LeapFrog Enterprises, Inc. (NYSE:LF)... one of the market's most underestimated names out there right now.
Just to frame things, since August, LF shares have lost 30% of their value. A dip of that size compared to the market's 10% rally during that timeframe would imply the maker of interactive learning toys was in serious trouble. It wasn't, though. In fact, LeapFrog Enterprises has been nothing less than a smashing success in the two quarter's it's logged in the meantime.
For perspective, the company earned $0.60 per share in the critical fourth quarter of last year. That was 22% better than the year-ago figure. For Q3, LF generated income of $0.60 as well, up from $0.35 per share in the third quarter of 2011. Both earnings results topped estimates too, of $0.49 and $0.42.
If you think it was some sort of accounting shell-game LeapFrog pulled off, you'd be wrong - the company pumped up its sales to similar degrees. The fourth quarter's top line of $244.7 million was 16% better than the prior year's Q4. Third quarter's revenue of $193 million beat the prior year's top line of $151 million by 28%. Indeed, each of the company's past four quarters have shown stronger year-over-year bottom and top lines. For a company that's allegedly in so much trouble that its stock tanks 30%, LeapFrog Enterprises sure is doing well.
It all begs one question... what were the doubters so worried about?
Perhaps the overarching worry was that LeapFrog's foray into the children's tablet market with the LeapPad (and the LeapPad 2) would simply invite other - and perhaps better or cheaper) competition into that same market. And, it did. Toys R Us came up with its own tablet, and other brands like the Tabeo and the Nabi were right in LeapFrog's heels. Thing is, the LeapPad still outsold them all; LeapFrog Enterprises' numbers verify it.
The market doesn't seem to recognize that reality at this point, or maybe it just doesn't care. But, it's unlikely the market will be able to continue pretending LF is a liability for much longer; the metrics are just too juicy.
As it stands right now, LF shares are valued at a TTM P/E of 6.76. That's a real, operating P/E too - no one-time windfalls. The TTM price/sales ratio is a mere 0.97, versus the market's average of around 2.4.
So why is LeapFrog Enterprises being sold off so firmly? As is so often the case, the market prices stocks at values they think it will be worth six to twelve months in the future. In this case, the market seems to be figuring that the company will hit a wall. Here's the problem with the theory..... if it hasn't happened yet, what's going to make it happen now? We've seen four straight quarters of monster-sized revenue and earnings growth.
But the pace of children's tablet sales can only slow? Maybe, but not likely, and a little irrelevant. LF is rapidly venturing into the learning arena, with apps... an arena with a longer shelf-life. Indeed, it never really goes out of style. It's also (finally) venturing into non-English-speaking markets with a reworked version of the LeapPad device. It's also now making a point of staying ahead of the competition by building a robust ecosystem of apps - what could have been a weak point in the armor.
The bullish clincher is that the analyst community is currently betting that LF is going to earn less in 2013 than it did in 2012. After beating EPS estimates in fourteen of its last sixteen quarters though - and six straight quarters of revenue growth - that's a bad bet. The market should start to figure this out soon, with the stock's P/E as low as it's been in years.
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