3 Reasons I'm Buying These 2 Terrific Toymakers

As we hurtle toward the holiday season and a new year, my next two investments for the Real Money Stock Picks portfolio I manage for the Fool have me channeling the spirit of the season.

Tomorrow, I'll be adding shares of both Mattel (NASDAQ: MAT  ) and Hasbro (NASDAQ: HAS  ) to the Defensive Value Investing portfolio.

The whole idea driving my investment strategy here is rather simple: Buy stable, safe companies with strong track records of rewarding shareholders over long periods of time. And I believe I've found two such gems in Mattel and Hasbro.

So without further ado, let's look at the reasons I believe Mattel and Hasbro are worth investors' attention today.

Reason No. 1: Mattel and Hasbro are industry leaders with fantastic economics
Although the global toy market is rather fragmented, between the two, Mattel and Hasbro dominate an impressive 30% of it. And both companies own some of the most recognizable toy brands in the world. For Mattel, that includes Barbie, American Girl, Fisher-Price, Hot Wheels, and Matchbox. Hasbro owns world-renowned toy franchises such as Play-Doh, Monopoly, Nerf, G.I. Joe, and Playskool.

What I love about both Mattel's and Hasbro's product portfolios is the timelessness of their brands. Although new trends will invariably come and go in the global toy market, you can rest assured that parents will still be playing Monopoly with and buying Barbies or Play-Doh for their kids for generations to come. And as one might surmise, those timeless toy franchises help power amazingly consistent financial performances for Mattel and Hasbro in both good times and bad.

In fact, when you look at both companies' financial statements over, say, the past 10 years, Mattel and Hasbro look nearly indistinguishable. In the past decade, both companies' gross margins have hovered consistently right around 50%, and their profit margins have buoyed close to 10%. Of course, you get some slight fluctuation depending on the overall strength of economy in any given year.

You can rest assured that year in and year out, people will buy toys, and that Mattel and Hasbro will always be there to supply them. 

Reason No. 2: Mattel and Hasbro are dividend dynamos
Mattel's and Hasbro's long tradition of powerful payouts serves as another compelling reason they deserve a spot in the Defensive Value Investing Portfolio. Just look at some of their dividend stats, and you'll see what I mean.

 Metric

Mattel

Hasbro

Current yield

3.2%

3.1%

10-year dividend CAGR*

13.7%

29.6% 

No. of years of consecutive dividends

22 

32 

Sources: Mattel and Hasbro Investor Relations. CAGR = compound annual growth rate.

In a world where the 10-year Treasury yields 2.8% and the S&P 500 yields 1.9%, the prospect of such fantastic income potential should have long-term investors salivating. However, Hasbro and Mattel take things one step further on the dividend front.

Mattel and Hasbro have a long tradition of growing their dividend at outsized rates. That's important here for two reasons. First, managing the Defensive Value Investing Portfolio is a long-term endeavor. I'll rarely buy anything even close to being classified as a growth stock, which means I'll have to find companies that can consistently reward their shareholders through return drivers such as dividends and buybacks. Secondly, the defensive nature of my portfolio is by definition loss-averse, and companies with strong histories of dividends and buybacks, like Mattel and Hasbro, reduce the risk that I could be faced with a permanent impairment of my invested capital here.

There's no question that I'll sleep more soundly, and quite possibly outperform over the long term, thanks to the dividend prowess of Mattel and Hasbro.

Reason No. 3: Fantastic economics, fair price
By this point, hopefully I've convinced you that both Mattel and Hasbro are clearly above-average companies. However, the price you pay for any investment has as much to do with its success as with the business itself.

And while I'd love to be buying them at cheaper prices (when hasn't an investor ever said that, though?), I'm perfectly comfortable pulling the trigger on both companies at their current trading multiples.

Metric 

Mattel

Hasbro

Market cap / levered free cash flow

22.3 times 

15.0 times 

Levered free cash flow yield

4.5%

6.6%

Long-term analyst growth estimate

9.4% 

8.9% 

Source: S&P CapitalIQ.

Apologies if the terms I selected in that table seem a little jargony. Levered free cash flow simply refers to the portion of a company's free cash flow that's left over after subtracting interest payments. Put another way, it's the figure that equity investors would receive during any given period. Mattel's and Hasbro's cash flow yields might not blow you away here. However, when you factor in additional return drivers like their 3%-plus (and growing) dividends, plus the potential for buybacks and long-term estimated growth rates between 8% and 9%, an investor's long-term return profile gets attractive quickly.

It's worth briefly noting as well that I'm generally quite skeptical of analysts' long-term growth estimates. I believe they tend to be vastly too optimistic. However, as my thinking here goes, even if Mattel and Hasbro achieve just half their estimated growth rates, they still stand a strong chance to outperform over time when you factor in the additional return drivers I mentioned.

If the analysts turn out to be right here, I'll do even better by owning Mattel and Hasbro. However, succeeding (or at least not losing money) isn't nearly as dependent on either company's hitting these growth rates as it is for lesser companies, and I'm just fine with that.

Foolish bottom line
At the end of the day, I'm extremely comfortable putting $1,000 into both Hasbro and Mattel, which I'll be doing tomorrow.

To me, both are fantastic businesses that should be able to weather the test of time and provide attractive, and possibly stellar, returns for years to come.

As someone looking to preserve capital as much as grow it, I love to think about Warren Buffett's famous saying: "The first rule of investing is don't lose money. The second is don't forget rule No. 1." And thankfully, with Hasbro and Mattel playing their part in my portfolio, I'll be doing just that.

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  • Report this Comment On December 17, 2013, at 6:54 PM, Mliaom wrote:

    Welcome aboard Andrew! I think they are slightly richly valued at this level, but long term, Forget about it! Really buy and forget about it, maybe even put it on DRIP.

  • Report this Comment On January 12, 2014, at 8:32 AM, Ravenor wrote:

    Do not forget the movie licensing deals Hasbro has with Transformers and Joe! I am trying to forget the abomination that was Battleship....still...good income for the company.

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