5 Superball Stocks

"'Don't catch a falling knife' ... The idea of buying a former superstar stock at a discount price certainly has its attractions, but you've got to make sure you catch the haft -- not the blade."

So runs the thesis of my recurring Fool column "Get Ready for the Bounce," in which we search among the wreckage of Mr. Market's overturned cutlery drawer, hoping to find future winners in a pile of 52-week losers. But do we really need to sit around for a whole year, waiting for a potential bouncer?

I say nay. Sometimes, stocks fall far in far less time than a year -- and like a superball dropped from the balcony, the harder they fall, the higher they bounce. Today, we're going to look at a few equities that've suffered dramatic drops over the past week. With a little help from the 140,000 members of Motley Fool CAPS, we hope to find an opportunity or two for you:

Companies are selected by screening on finviz.com for abrupt 10% or greater price drops over the past week; 52-week high and recent price data provided by finviz.com.

Five super falls -- one superball
Last week was a rough one for the five companies named above. Denbury reported a significant slip in third-quarter profit, while weaker-than-expected guidance for future earnings was the problem at both Whole Foods and CVS Caremark. Geron's decline was perhaps strangest of all, as it was apparently sparked by an analyst's musings over weak prospects for "near-term newsflow."

But it's the story at JAKKS Pacific that intrigues me most this week. The games maker saw its stock slide 15% Wednesday, apparently for no reason more serious than its decision to issue debt to pay off ... other debt. Was the sell-off justified?

You tell me, after reviewing the following information.

The bull case for JAKKS Pacific

• CAPS member tekennedy praises JAKKS for having "a business model I like ... a solid balance sheet and ... solid free cash flow ... Their outsourced manufacturing replaces fixed costs with variable costs, helping improve profitability during periods of lessened demand. Although I normally would like ownership of intangible property I believe in this instance their strategy of licencing "evergreen" brands (brands which are relatively old, like Pokemon or WWE, whose demand is more stable and less prone to fads) has enabled them to develop a greater portfolio of brands and earn a relatively high ROIC. A good portion of the market cap is in cash and the current price is fairly close to (tangible) book value."
• pest6633 agrees, and points out: "Toys and leisure always seem to do good in bad times. plus [the stock trades] close to book value."
• One of our very best investors on CAPS, mrindependent, agrees that "this stock is cheap ... Aside from its appealing valuation, the company boasts capable management that seem to understand the need to reposition the company's products for tough economic times."

So is that what JAKKS was doing when it raised cash last week? Getting ready for tough economic times? Actually, I don't think so. I think JAKKS was getting ready to capitalize on opportunity. Consider: JAKKS sold $85 million worth of convertible debt last week, with the stated purpose of paying off convertible debt due in 2023. But the new notes are due in 2014. So why pay off longer-term debt by taking out shorter-term debt?

I'd argue that JAKKS did this because it expects to do awfully well in that shorter term. And in fact, its sales performance in the most recent quarter was about equal to Hasbro's (NYSE:HAS), and superior to Mattel's (NYSE:MAT). It's also interesting to see that, in raising cash to pay off its old debt, JAKKS decided to take out cheap convertible debt rather than issue shares. This suggests to me that JAKKS thinks its shares are at least somewhat undervalued, and that it's better off keeping some debt on its books, rather than diluting its shareholders now at a discount.

JAKKS-in-a-box
And if that's the thinking at JAKKS, I'd have to agree. Although currently "unprofitable" as GAAP measures such things, JAKKS generated $58 million in cash flow over the past 12 months. With capital expenditures around $21 million, this works out to about $37 million in free cash flow -- a far cry from "unprofitable."

It also means that JAKKS sells for about 9 times its annual free cash flow, in an industry primed for 13% long-term growth. The business is even cheaper if you factor in its net cash position of $56 million. And to me, that sounds like a bargain.

Time to chime in
Of course, if you ask the analysts who track JAKKS, they predict the company will average barely half the growth rate of its peers: 8%. I think it unlikely that JAKKS will perform so poorly, and management's refinancing actions suggest that they, too, are preparing to surprise the Street.

So will JAKKS jump out of its box and scare the skeptics? You tell me.

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