3 Back-to-School Stocks

Through the end of August, goback to schoolwith The Motley Fool. You'll find more educational book reviews, stock analysis, and financial advicehere.

It's that time of year again for parents -- time to get the kids the heck out of the house. But the price you pay can be steep. Clothes, iPods, cars, Biore strips, it all adds up. The good news? Thanks to the magic of the stock market, parents have a chance to make back some of what they lay out at back-to-school time. In fact, some of the very same places you spend may be the best places to look for a return.

Too cool for school
You parents out there think you spend a lot of money putting threads on those teenagers and new collegiates? You do. I know, because I follow American Eagle Outfitters (Nasdaq: AEOS  ) , which gets a large part of that budget -- $2.3 billion last year alone. American Eagle is one of the strongest brands out there for the older-teen and college crowd, as brand surveys have suggested, and as sales and earnings growth prove.

Unfortunately, the time to make a big, quick killing in this stock has passed. We'd all have been much better off buying on the pessimism a year ago. (Well, some of us did.) But as high as the eagle has soared, I think it's still got plenty left to give to investors. There are two reasons I still think American Eagle is still a good buy. One is growth prospects. From undies to the new Martin + Osa concept for the older crowd, American Eagle still has significant room to expand its audience, brand, and revenues.

But a better reason to consider this stock is what happens to that money. American Eagle generates very respectable free cash flow -- far better than most retailers. If you've been in the duds game, you've seen companies come along and plow all their cash back into stores and infrastructure that may ultimately fail to provide future economic benefit. Not so with American Eagle. Even after expanding and upgrading, there's plenty of cash left over.

When I put a price tag on the future of that cash flow, using positive but not overly optimistic growth estimates, I come up with a fair value of nearly $45 per share, for a 20% margin of safety at today's prices. Even the most die-hard bargain hunter would have to admit, that's a pretty decent deal on one of the hottest brands around.

All work and no play makes Jack a dull boy
The days are long past when a Frisbee or Hackey Sack would count as primo study-break entertainment. In fact, I'm pretty sure packing your kids off to school without a suitable gaming rig might get you hauled into court on child abuse charges, at least in California.

Video games are more than just a brainless diversion, of course. Linked via instant messaging and voice chat, video games are a new way of socializing, connecting friends across oceans and continents. You already know your kids are spending too much time fragging each other or saving the world from all those nasty Orcs. What are you going to do about it?

I say, buy into the industry.

Games are a huge business that'll only keep growing. Motley Fool Stock Advisor selection Electronic Arts (Nasdaq: ERTS  ) sold nearly $3 billion worth of entertainment last year.

But you may not know that the biggest players in the game space have been in a bit of a downward spiral lately. True, they're no longer as cheap as they were back in July, owing to a market that became upbeat following some surprisingly strong one-month sales results. Still, I think they're cheaper now than they will be in the months ahead.

Taken in isolation, those inspiring late-summer sales don't spell the end of the trend. However, I think they awakened Wall Street to something it's known all along: The crummy trend will end soon enough. Some potent catalysts should arrive in mere months, when Sony and Nintendo unleash their next-generation gaming systems. Microsoft's (Nasdaq: MSFT  ) Xbox 360 has been around for a year, to very good reviews but less-than awe-inspiring sales, but the hype about the game-system head-to-head for the coming holiday season should help build interest in all the players.

Sure, this will mean a console war for the box-makers, but by betting on the biggest game-makers, you don't really have to pick a winner in the hardware space. Unless the U.S. economy falls flat on its face in the coming months -- which I don't think will happen -- I believe all the gamers will be trending upward in the coming months as the game industry winds up for the holidays.

You want a fire extinguisher with that?
Yes, Dell (Nasdaq: DELL  ) is the butt of many a joke these days, as video of laptops bursting into flame led to Internet infamy and a battery recall that will cost hundreds of millions of dollars. But those costs look like they'll fall to poor Sony, the maker of the batteries in question. And just when all those smug Apple (Nasdaq: AAPL  ) owners out there were getting their shame on, Cupertino announced a huge recall of its own Sony batteries as well.

Dell isn't on my list because it stands to benefit from any big back-to-school shopping spree. It just happens to look pretty cheap this fall, despite all its other troubles. Yes, I know about the major earnings drop-off. I know about the still-unsolved customer-service troubles. And I know all about margin pressure being driven by revamped operations at the likes of Hewlett-Packard (NYSE: HPQ  ) and Lenovo -- which has been poaching Dell's executives, by the way. I know all that stuff because I've been the office Dell bear for some time.

But the beauty of investing is that it's all about the money -- which means you get to flip-flop, especially when the price looks right and there are catalysts on the horizon. With chip makers engaged in a price war that will give consumers and enterprises far faster chips, and Windows Vista primed to make a late-2006-to-early-2007 entry, I think the natural urge to upgrade will breathe new life into Dell's sales. Over the long term, I think Dell will either push CEO Kevin Rollins toward a greater faith in style and lifestyle-inspired innovation (a la Apple) or push him toward the door.

My fairly conservative valuation pegs these shares at a fair value of $27 each these days. That means a 17% discount to today's prices. If the back-to-school season gives us another shot at $21 or $20, I'd say that's just one more bargain too great to pass up.

Dell and Microsoft areMotley Fool Inside Valuerecommendations. Activision, Dell, and American Eagle Outfitters areStock Advisorrecommendations. You can try any of our premium newsletter services for a month, risk free.

At the time of publication, Seth Jayson had shares of Electronic Arts, American Eagle Outfitters, and Microsoft, and was long Microsoft calls. He had no positions in any other company mentioned. View his stock holdings and Fool profile here. Fool rules are here.


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