Throw This Stock Away

The house rules are simple in this weekly column.

• I bash a stock that I think is heading lower.
• I offset the sting by recommending three stocks as portfolio replacements.

Who gets tossed out this week? Come on down, LeapFrog Enterprises (NYSE: LF  ) .

This frog is no prince
Shares of LeapFrog were trading as much as 15% higher today, after the edutainment toy maker generated blowout quarterly results.

On the surface, it's easy to get carried away with the enthusiasm. Net sales climbed 23% to $138 million, fueled by the popularity of its toy lines and higher price points at the retail level. Earnings more than doubled to $0.24 a share. Well done, LeapFrog. The pros were banking on a profit of only $0.18 a share on $133 million in revenue.

However, shouldn't this kind of earnings beat be accompanied by a supersized guidance update? It wasn't. LeapFrog is actually sticking to its guidance of 15% to 20% in top-line growth with earnings clocking in between $0.20 and $0.30 a share.

Net sales have grown at a 27% clip through the first nine months of the year, so we're talking about continuing deceleration -- and dramatically so. The bottom-line outlook doesn't mean that LeapFrog generated all of its profitability during the third quarter. It's actually still in the red for the year after posting a chunky seasonal deficit during the first half of the year.

However, analysts that were banking on net income of $0.64 a share during the holiday quarter may need to rethink their targets. The $0.64-a-share estimate would result in an annual profit of $0.32 a share. Why didn't LeapFrog raise its full-year range by a nickel per share, or so?

LeapFrog may have some compelling electronic playthings in its arsenal, but it's been burned by finicky kids before. There are some unlikely high-end challengers, including this month's release of Barnes & Noble's (NYSE: BKS  ) NOOKcolor, which will offer interactive children's picture books, bringing kid-friendly classics to life in a way that LeapFrog cannot.

The only secret sauce I like in LeapFrog these days is its Learning Path initiative, where parents can track their children's progress online through its educational toys. It's a free tool with 4 million registered users, and it does build brand loyalty and incremental purchases. Unfortunately, that's just not enough to justify a company with a volatile history -- including several years of annual deficits before breaking back into the black this year.

You can do better. You can leap the LeapFrog.

Good news
As I do every week, I don't talk down a stock unless I have three alternatives that I believe will outperform the company getting the heave-ho. Let's go over the three fill-ins.

• Apple (NYSE: AAPL  ) : LeapFrog's portable Leapster Explorer is a hit. It's a kid-sturdy handheld unit, along the lines of Sony's (NYSE: SNE  ) PSP or Nintendo's (OTC BB: NTDOY.PK) DS, but with chunkier buttons and lousier graphics and gaming-related specs. It sells at a reasonable $70, but then come the extras. Every learning game sets a budget back by $25. A digital camera add-on with crummy resolution and limited storage is another $25. Now let's consider Apple's recently refreshed iPod touch. At $229 it may not appear to be much of a bargain, but keep in mind that a legitimate digital camera and access to countless free -- or nearly free -- app downloads is part of the package. Add a case and it's as sturdy as the Explorer, for something that a kid won't outgrow in a few months.
  
  
• Hasbro (NYSE: HAS  ) : The country's second-largest toymaker may not seem impressive at first glance. Revenue and earnings per share climbed a mere 3% and 10%, respectively, in its latest quarter. However, Hasbro's performance is pitted against last summer's, when its G.I. Joe and Transformers lines had theatrical releases to boost results. I can't see LeapFrog milking any of its proprietary toy lines as bankable Hollywood characters. Hasbro provides the consistency that LeapFrog can't. It has been consistently profitable. It has blown past Wall Street profit estimates in six consecutive quarters (whereas LeapFrog fell short just two quarters ago). It's also reasonably priced at 17 times this year's projected earnings and 15 times next year's mark. LeapFrog may appear cheaper when eyeing next year's guesstimates, but its historical hiccups make looking too far ahead a dangerous preoccupation for shareholders.
  
  
• RC2 (Nasdaq: RCRC  ) : The company behind Ertl die-cast vehicles and Learning Curve wooden train sets disappointed investors two weeks ago. Unlike LeapFrog, the maker of more traditional playthings and toddler-care products missed Wall Street's targets. However, just like LeapFrog, it stuck to its earlier full-year guidance. I can appreciate the near-term implications. I can also appreciate the value. RC2 is trading for just 14 times this year's earnings and 11 times next year's bottom-line target. It's a cheaper play and in a throwback niche that has longer lasting power than LeapFrog's never-ended tech race.

I'm sorry, LeapFrog. Back to the pond you go. Please take our Motley Poll then scroll down to the comments section to let your fellow Fools know why you made your choice.