2 Stocks With Big Upside Before the End of 2014

Although the S&P 500's 9% year-to-date rally should be exciting for investors, not all stocks have come along for the ride. For example, Mattel (MAT -0.60%) and Generac (GNRC 0.92%)are down a whopping 28% and 25%, respectively.

But that might change heading into the holiday season and winter months. Before delving into why the stocks of the toy maker and the generator company have so much upside, let's look into what took them lower. 

Mattel's story
Mattel is one of the largest toy manufacturers in the world, responsible for brands such as Barbie, American Girl, Hot Wheels, and Fisher-Price (among many more). However, sentiment has rapidly soured, as the company's quarterly reports have been underwhelming.

Mattel has missed earnings per share estimates in each of the past three quarters and revenue estimates in the past two quarters. This has resulted in a reduction of full-year earnings-per-share and revenue projections, as analysts now expect the company to bring in less sales and net income than last year.

Source: Estimates taken from Yahoo! Finance.

Sales in the first two quarters of fiscal 2014 slumped 6.83%, and the company broke even for the first half of this year. It hasn't been pretty, and the share price reflects that. 

What about Generac?
It hasn't been as bad for generator maker Generac. In the first quarter of fiscal 2014, year-over-year revenue slumped 14.4% to $342 million. It's never good when investors see a double-digit drop in sales. 

However, the company attributed this drop to two events. First, the cold and harsh winter weather delayed generator installation. Second, this year did not include the after-effects of Superstorm Sandy, which slammed into the East Coast in the fourth quarter of 2012, temporarily increasing sales of Generac products.

More promisingly, Generac actually boosted revenue by 4.6% in the second quarter. Still, in the first half of this year, sales and earnings per share were down 5.6% and 28.7% compared to 2013. 

Didn't I say these stocks had upside?
Despite information that might make these two stocks appear to be pretty poor long candidates going into the end of 2014, there is actually some appeal. 

First, Generac is mainly a generator play. In other words, the bulk of its business is usually done in the months leading up to winter and during winter itself. That means the company's third and fourth quarters are generally strong.

Mattel also typically is strong in the third and fourth quarters, thanks to the holiday shopping season. The fear here, though, is that electronics -- such as tablets and video games -- are starting to overtake the Barbies and Hot Wheels of the world. While that may be true, it is not a trend that will overthrow traditional toys immediately.

It's not entirely surprisingly that these stocks have fallen out of favor during their slow time of year. 

My bull thesis would go something like this: 

• The stocks have been mercilessly sold in 2014.
• Shares are likely near a bottom, headed into a historically prosperous winter season.
• Declining fuel prices and a labor market that is the strongest it's been in years should boost consumer spending.

But just because sales increase, that doesn't mean these two stocks will automatically go higher. But I think we've seen an overreaction in the pessimism department. In other words, perhaps these two stocks didn't deserve to be trading as high as they once were, but they don't deserve to be this low.

Right now, they're undervalued. And after a few strong quarters of earnings and sales, I think investors will feel the same way, too. Take a look at the companies' price-to-earnings (P/E) ratios to get a sense of where investors typically start to find these investments attractive again:

MAT P/E Ratio (TTM) data by YCharts

As you can see, the trailing P/E ratios are near the lower end of the recent range, not the upper end. Once sentiment shifts, I think that's when the share prices will really start to move higher, as investors start valuing the companies more fairly. 

What else is there to like? 
While I don't really focus on trading, I think there is something to be said about seasonal movements. To me, that's not trading. It's simply selecting the best time to invest in a particular stock. 

Below are two charts in which I have highlighted, in red, the midyear bottoming of the stock, which typically happens between July and September, before it moves higher into the end of the year.  

MAT data by YCharts.

GNRC data by YCharts.

I'm not suggesting buy in July, sell in January. I'm suggesting that these two stocks tend to fall out of favor in the spring and summer, and into favor in the fall and winter. So long as the stocks do not have an overly ambitious rally in the ensuing months, I think today's prices offer attractive entries for a long-term hold. 

Optimistically, it would be nice to see each company recoup its year-to-date loss. However, that would require more than a 40% move in the stock prices. 

Both companies have been severely beaten down, but they are coming into the seasonally strong period of their respective businesses. Because of the economy, I expect the next six months of business to fare well, and it doesn't hurt that Mattel also pays a handsome 4.4% dividend yield.  

Typically, buying a stock when the news seems to be at its worst can pay off the most in the long run. I would expect these two companies to be good investment opportunities.