Could Mattel's Stock Double Your Money?

Recessions are anything but fun and games, but if we look at the results out of Mattel (NYSE: MAT), it's pretty apparent that playtime didn't stop completely during the most recent downturn.

Even though the recession was longer and deeper than anything that the U.S. has seen in decades, Mattel stayed solidly profitable through the slump. And though results did decline, it still delivered a return on equity that most companies would love to record during good times. Perhaps while parents were good about saying "no" to their own wants, they had more trouble telling their kids they couldn't have a new Barbie doll or Thomas and Friends engine.

Of course, even though browsing Mattel's list of all-star toys may bring back fond childhood memories, the question for us Foolish investors is whether the company's stock could bring us some grown-up smiles. Let's take a closer look.

Earnings expectations
As I outlined in a previous article, a good way to get a baseline for growth expectations is to check on what Wall Street analysts expect and how fast the company has actually grown in the past.

Source: Capital IQ, a division of Standard & Poor's. Historical growth based on operating earnings.

The company's three-year growth is juiced by the fact that the starting point is the recessionary low point in 2008, so we should bear this in mind when setting our expectations.

So where will growth come from, and how much can we actually expect? The source will be the company's tried-and-true brands, such as Barbie and Hot Wheels -- which it can sell both in the U.S. and through its global footprint -- as well as new product lines from organic development and partnerships with entertainment brands such as Blue's Clues, SpongeBob SquarePants, DC Comics, and Avatar. (Author's note: My research got interrupted for 15 minutes here as I browsed Mattel's collection of retro action figures.)

As for how fast the company can grow, to be conservative, I set the midpoint of my growth estimates at 7% to mirror the five- and 10-year rates. If the economic recovery doesn't completely slip away from us, the company could get even more momentum and earnings per share will grow quicker than operating earnings if the company continues its share buybacks (it repurchased almost $600 million over the past 12 months). But I'm happy using a more conservative estimate and providing room to be surprised on the upside.

Speaking of upside, I used the analysts' average estimate of 10% as my optimistic case, while I throttled growth down to 5% per year for my downside case.

Pinning down valuation
Valuations are a moving target that can be tough to predict, but, as with growth, using a range of values can give us a view of our potential returns without requiring a Miss Cleo-type prescience.

In creating our range, a good place to start is where the stock is trading right now and what its historical trading range has been. Mattel's stock currently changes hands at 13.5 times trailing earnings, which is historically low for the stock but not unheard of. Over the past decade, the stock has spent a lot of time between 12 and 19 times earnings.

For broader context, we can also look at how similar companies trade.

Source: Capital IQ, a division of Standard & Poor's.

Obviously, these companies aren't all exactly the same. Hasbro is the most obvious fit as the archrival of Mattel. Jarden sells a wide variety of products that range from Crock Pots to First Alert alarms, but also includes Bee and Bicycle cards, Rawlings baseball gear, and Ugly Stik fishing rods. And though both Electronic Arts and Activision focus on video games, we don't want to ignore them as important competitors for the money being spent on kids.

So where does Mattel fall in the group? With a forward P/E of 12 and an analyst-estimated growth rate of 10%, its PEG comes out to 1.2, which puts it at the very top of the group. It concerns me a bit that Mattel's multiple looks pricey on that measure, but it's still toward the lower end when we consider the P/E multiple alone. I also think that the sector as a whole -- particularly the kingpins of Hasbro and Mattel -- may be underpriced.

For my model, I made the rather bullish assumption that Mattel's multiple would rise to 15 to be more in line with where it's been in recent years. Optimistically, I could see investors boosting the multiple to 19, while I could also see it staying stuck around 12.

Dividends and share count
Our final stop is to consider how much we'll get paid through dividends and whether changes in share count will affect our bottom line.

What worries me most about share count is that a company will issue boatloads of shares and dilute my ownership stake. I don't think Mattel gives us too much to worry about there. At the end of 2001, the company had 436 million shares outstanding. Today it has 357 million shares outstanding. There have been years where the share count has climbed, but on the whole it's been a downtrend.

As for dividends, Mattel doesn't have a track record that's going to wow hardcore dividend investors, but I don't think we'd be crazy to expect that the company could continue paying and growing its dividend going forward. On the high end, I could see annual growth of as much as 12% -- which is consistent with its five-year rate -- and on the low end I expect at least 5% annual growth. For my middle case, I used a rough midpoint of 8%.

The verdict, please!
The end result of all of this is the returns we can expect under the various scenarios. Here's what my three scenarios would look like.

Source: Author's calculations.

To answer the question I asked in the title -- could Mattel's stock double -- we could give an emphatic "yes!" if we believe the optimistic case above. If we're "stuck" with the middle case, the next five years won't bring a double, but it won't be too far off. And while the downside case would be far from a double, a 6.4% annual return isn't a terrible downside.

I have my money where my mouth is on this one -- Mattel is part of my personal portfolio. I've also given the stock a thumbs-up in CAPS, so that my call can be tracked over time.

Of course, the future is an ever-changing picture, so you need to keep on top of what's going on at Mattel to see which set of numbers the company and stock are able to live up to. And you can do just that by adding the stock to your Foolish watchlist. Don't have a watchlist yet? Start one up now!