Holding Mattel Ahead Of Earnings (NASDAQ:MAT)

It’s been about three months since I bought Mattel Inc. (NASDAQ:MAT) ahead of earnings, and, on the eve of annual earnings on February 8th, I thought I’d review the name again. The shares are up about 2% against a gain of 5.5% for the S&P 500. I’ll decide whether or not it makes sense to remain long here by reviewing the latest financial results, and by reviewing the valuation.

Welcome to the “thesis statement” portion of the article. This is where I offer you the highlights of my thinking so you can understand where I’m coming from without the need to read the entirety of my thinking. I write a thesis statement at the front of each of my articles as a way to potentially save you time. You’re welcome. My attitude about buying Mattel, as with all companies, is that it helps to be as simple as possible. Narratives and stories we tell ourselves about why we buy sound compelling, and they help investors sell product, but really this is all about paying as little as possible for high profits. That’s the strategy in a nutshell. Although it’s not as compelling as many investing stories I’ve read, I’ve done very well with it. With that in mind, I think the financial history here is rather good, but the shares are neither cheap nor expensive on the eve of the next earnings report. For that reason, I’ll neither add to nor sell my Mattel stake at the moment. I may take action if I’m surprised, but for the moment, I’m comfortable doing nothing. Additionally, while I really like the risk-reducing, yield-enhancing potential of deep out-of-the-money put options, I think the premia on offer are too thin at the moment. Thus, I think the stock itself represents a better risk adjusted return at the moment. If you’ll forgive the cheesy pun, the stock is a better way to “play” this investment at the moment in my view.

Financial Snapshot

I think the latest financial results have been rather good, actually. Sales continue to rise nicely, with revenue up by about 10% compared to the previous year, and about 33% relative to the same period in 2019. At the same time, net income has fallen, from this time last year. The reason for this isn’t too distressing in my view. Last year the company enjoyed a $415.8 million benefit from income taxes, and in 2022, the company made a $130.5 million provision for income taxes. I like the fact that gross profit in 2022 was about 8% higher than it was in 2021, and fully 48% higher than it was in 2019.

It’s not all animated bluebirds and candycanes at Mattel, though. The level of indebtedness is still troublesome in my view, with long-term debt up by about $4.6 million relative to the same period a year ago. In fairness, I think it’s worth noting, that interest expense is way down relative to both 2021 and 2019. Additionally, in spite of an uptick in debt, the capital structure is slightly stronger because the company now has a full 13.5% of long-term debt outstanding in cash.

Given all of this, I’d be very happy to add to my position ahead of upcoming earnings on February 8th at the right price.

The Stock

My regular readers know that I consider the company and the stock to be very different things. If you’re new here, it’s time to let you in on this idea, too. I consider the stock and the company to be very different things. The company takes a number of inputs, adds value to them, and sells toys for a profit. The stock, on the other hand, is a traded instrument that reflects the crowd’s long-term views about the strength of the business. Additionally, the stock is affected by a number of variables that have little to do with the business, including changing interest rates, the crowd’s desire to own “stocks” as an asset class etc. In my experience, the only way to profit trading stocks is to spot discrepancies between the crowd’s views and subsequent reality. If the crowd is too pessimistic, for instance, it makes sense to buy and then ride the price higher as new information is eventually digested. If the crowd is too optimistic about a company’s future, it’s best to avoid the name in my view. The level of optimism or pessimism in a stock is reflected in the valuation. If the crowd is optimistic, the shares are not cheap and are likely not a great investment in my view.

I measure the cheapness (or not) of a stock in a few ways, ranging from the simple to the more complex. On the simple side, I look at the ratio of market price to some measure of economic value, like earnings, sales, and the like. I want to see the shares trading at a discount to both the overall market, and their own history. In case you don’t remember, I got pretty excited about these shares when they were trading at a price to sales ratio of 1.21 times, which was near a multi-year low. The shares are now only marginally more expensive per the following:

Similarly, the shares remain relatively cheap on an earnings basis, too, per the following:

It’s all well and good for me to write that the shares are cheap based on ratios, but I think it’s also helpful to work out what the market is currently “thinking.” As my regulars know, the way I do this is by looking at the work of Professor Stephen Penman and his book “Accounting for Value.” In this time, Penman walks investors through how, using the magic of high school algebra, they might isolate the “g” (growth) variable in a standard finance formula to work out what the market must be thinking about the growth of the business at the moment. This approach is interesting because it uses the price of the stock itself as a source of information about the assumptions the market currently has. The more optimistic those assumptions, the more dangerous the investment.

In case you find Penman a bit dense, I think Maubouissin and Rappaport’s book “Expectations Investing” is a bit more accessible and also uses stock price itself as a source of information. Anyway, applying this methodology to Mattel suggests that the market is assuming a growth rate for this business of about 3.75%. I think this is a reasonable expectation for long-term growth here, neither too optimistic nor too pessimistic. Given the above, I’m going to hold my position but won’t add to it.

Options As Alternative

My regulars know that I love selling deep out of the money put options at the right price. I think these have great potential to reduce risk while enhancing returns, so I always consider them. The problem is that the premia on offer need to be sufficiently great to make the exercise worthwhile, and that’s just not the case here at the moment. For instance, the July Mattel puts with a strike of $15 are only bid at $.35 at the moment, which represents a rather paltry 2.3% return. For that reason, I would suggest that if you’re just coming to this party, the best approach for you in my view would be to simply buy the shares. I think these represent the best risk-adjusted returns. If the shares fall in price, or if the options market offers greater premia, I’ll certainly change my mind here, but, for the moment, I think stocks are the way to “play” (forgive the pun) this stock.