10 Fad Stocks That Bounced Back in 2010

BOSTON (TheStreet) -- Legendary investor Peter Lynch's basic investment principle was to "invest in what you know," and that philosophy has paid off richly for consumers of products made by so-called fad companies like Crocs (CROX) and Krispy Kreme Doughnuts (KKD).

Stocks like Crocs and Krispy Kreme soared several years ago, as the companies produced extremely popular items. In the case of Krispy Kreme, it was warm glazed doughnuts fresh off the production line. For Crocs, it was colorful clogs made of foam resin touted for their ergonomic benefits.

Much like Beanie Babies, the Atkins Diet and, more recently, Silly Bandz, the initial craze eventually dies down. Stocks that skyrocketed on big revenue growth expectations experienced sharp declines in share prices as the froth petered out.

Some stocks, like fitness products maker Nautilus ( NLS), have yet to recover. Some critics argue that companies like Skechers USA ( SKX) or even Netflix ( NFLX) could be experiencing the beginning of the fad-stock decline.

For a handful of companies left for dead after the public lost interest in their products, 2010 was a winning year. Several fad stocks, like Crocs and Krispy Kreme, handily beat the S&P 500 and even the Russell 2000 index, which measures small-cap companies. However, these share-price rebounds were not accompanied by a renewed craze for the companies' products.

The reason for the rebound rally in these fad stocks is simple: Wall Street hated these stocks so much, they became an incredible value for investors.

"These faddy stocks become such a joke in the market," says Craig Hodges, portfolio manager of the Hodges Fund. Hodges is based in Dallas and his firm has about $900 million in assets. "They eventually become so oversold and hated that they become good buys. In most cases, the fad won't come back. But there can be enough of an underlying business there to make the company work."

Hodges, along with other money managers, has reaped the benefit of comeback stories like Crocs. Of course, the diligence needed to follow these beaten-up stocks is a heavy burden.

"I don't like to watch the fad stocks because you can spend a lot of time doing that and not get anywhere," says Brent Wilsey, president of San Diego-based Wilsey Asset Management. "You can like the product as a consumer, but it doesn't always mean it's going to be a great investment. But you can actually do pretty well by looking at the fundamentals."

Michael Corbett, manager of the Perritt Emerging Opportunities Fund, notes that looking at fundamentals provides a greater challenge than the individual investor may believe it to be. Corbett's fund looks for deep value plays but it also looks for growth stories at a reasonable price. Overall, the firm has roughly $600 million in assets under management spread across this fund and another microcap fund.

"You have to check under the hood and dig deeper to see if management is really bad and will burn the rest of the cash of the company," Corbett says. "That's the most difficult part of the process. And you have to do it in a diversified fashion."

Thankfully, individual investors have several ways to help determine if a fallen angel fad stock is poised for a rebound. First, several mutual funds offer investors the ability to find deep value plays with active management, leaving the work up to the fund manager. For those looking to do the diligence themselves, it pays to look for cash-generating companies with little or no debt.

"The story for the group is net cash and no debt," says Michael Benoit, equity analyst at Chicago-based Talon Asset Management. "There's not a lot of operating risk, in terms of the company becoming distressed. The downside is limited because you have some type of asset value protection. People view a lot of operating leverage in their earnings."

On the flip side, Brent Wilsey says there are several red flags investors can look for to help them determine with companies to avoid, such as negative cash flow and negative equity. Wilsey advises investors to examine the actual product, too.

"Look at Polaroid Camera. It was a great thing for a while but the technology was replaced. You want to make sure you're buying something that is low priced but also that they product won't be obsolete."

The following pages contain a look at 10 companies harshly branded as fads but that saw outsized gains in share price last year.

Jamba ( JMBA)

Company Profile: Jamba operates as a retailer of blended-to-order fruit smoothies, squeezed-to-order juices, blended beverages and snacks.

Current Share Price: $2.26 (Jan. 6)

2010 Share Price Gain: 30%

Comeback Story: Jamba Juice initially gained success in the late 1990s by offering customers a "soulful experience." The company was acquired in 2006 by Services Acquisition Corp. for $265 million, which shortly changed its name to Jamba, Inc. Throughout 2006, the stock traded around $10 before tumbling below $5 in late 2007 as the craze over smoothies died down. Net losses piled up in 2007 and 2008 while shareholders' equity took a hit. During the height of the credit crisis, shares of Jamba fell below 50 cents. However, in June 2009, the company transformed from a menu of smoothies to one that includes sandwiches and salads.

Canaccord Genuity analyst Scott Van Winkle is a believer in Jamba's transformation, as he has a "buy" rating and a $3.50 price target on the stock. Van Winkle wrote in a November research report that he believes Jamba has the brand, the management and the strategic operating model to deliver an efficient and profitable company.

"The big question with a turnaround always seems to be what to pay for it at various stages of the transformation," Van Winkle wrote. "Nonetheless, we are highly confident that the transformation will occur and have relatively high confidence in how the new business mix will impact profitability and returns on invested capital. We assume that Jamba can improve its financial model, expand its franchise base, turn comps modestly positive and build a robust licensing business."

Heelys ( HLYS)

Company Profile: Heelys is a designer of action sports-inspired products under the Heelys brand targeted to the youth market. Notably, the company's shoes, which feature a wheel in the heel, became extremely popular and were even banned from some schools.

Current Share Price: $3.04 (Jan. 6)

2010 Share Price Gain: 40%

Comeback Story: Heelys debuted on the Nasdaq in 2006 after an initial public offering and, at the height of the shoes' popularity in 2007, the stock flirted with $40. But by August 2007, Heelys noted that it was "experiencing challenges at retail related primarily to an over-inventoried position of product at many of the company's domestic accounts." By the end of 2007, the stock traded for $6. In 2008, Skechers offered to acquire Heelys for $143 million, or $5.25 a share. By the beginning of 2009, Heelys fell to nearly $1 and the CEO resigned. Heelys announced the hiring of a new CEO in July 2009 and later settled litigations in connection with its IPO.

Wilsey says that Heelys does make some sense as an investment. "The debt-to-equity ratio is zero. This company is just loaded with cash. It can't go bankrupt because it has a good balance sheet. It won't be a big boom company, but it's a good business that can actually make money. If they can just increase their sales just a little bit, whether they sell overseas or in emerging markets, this makes some sense."

Michael Corbett, manager of the Perritt Emerging Opportunities Fund, which owns shares of Heelys, says he's not sure what the long-term success of the company will be. "We got hold of a big block of stock below basically net-net. It came available from a shareholder who just needed out, so we picked it up significantly below book value. Fundamentally, I'm not really sure longer-term what will happen with the company, but management as outlined some interesting things to us from the standpoint of trying to get back to basics and turn this thing around. But there was really no downside."

Build-A-Bear Workshop ( BBW)

Company Profile: Build-A-Bear Workshop is a retailer of plush animals and related products, allowing customers to create their own plush bears.

Current Share Price: $7.44 (Jan. 6)

2010 Share Price Gain: 58%

Comeback Story: Build-A-Bear went public in 2004 and aggressively grew the number of stores globally. However, the recession took its toll on the retailer, and same-store sales cratered. The stock fell from $30 in June 2007 to below $4 by the end of 2008.

One of Build-A-Bear's biggest catalysts has been reported interest from private-equity groups. Bloomberg reported in December that Build-A-Bear is seeking a buyer and has approached private-equity firms, citing people with knowledge of the matter.

Susquehanna International Group analyst Thomas Filandro wrote in a recent research report that he believes a deal makes sense for Build-A-Bear. He also notes several positive attributes of the company, including "high cash flow generation, healthy balance sheet, reasonable inside ownership, unique brand concept offering an emotionally connective product and shopping experience, and brand presence both domestically and internationally provide a solid platform for future growth."

Filandro has a "positive" rating on the stock and a 12-month price target of $10, although he adds that the Build-A-Bear concept is "a faddish business, with limited barriers to entry. Stores are highly reliant on mall traffic to drive transactions and comp growth."

Fossil ( FOSL)

Company Profile: Fossil designs and sells consumer fashion accessories, including popular lines of watches, belts and handbags.

Current Share Price: $72 (Jan. 6)

2010 Share Price Gain: 108%

Comeback Story: Fossil shares could be bought in 1993 shortly after the company's IPO for roughly $2 on a split-adjusted basis. The stock rallied to $30 in 2004, but the company was hurt by soft sales and margins heading into 2006. At the time, Fossil's CFO said the company would be forced to hold itself to "more modest sales growth expectations and focus on reducing our expenses accordingly" until it could generate a catalyst to reinvigorate watch sales. By early 2009, shares of Fossil could be bought for less than $12.

"This was very much a fad for a while with the watch business," says Hodges. "They restructured and moved into the retail store business. Fossil, of course, has continued with the watch business but I wouldn't consider it a fad now. It's a staple now."

Hodges offers the example where Fossil recreated the diamond-crusted white watch Sandra Bullock wore in the popular movie The Blind Side. "They do a lot of that stuff where they hit areas that are popular. Fossil has been the exception in that they've transformed the business and they're fantastic at what they do. They're great marketers."

Lululemon Athletica ( LULU)

Company Profile: Lululemon designs and markets healthy lifestyle inspired athletic apparel, which is sold through a chain of corporate-owned and operated retail stores, independent franchises and a network of wholesale accounts.

Current Share Price: $68.49 (Jan. 6)

2010 Share Price Gain: 126%

Comeback Story: Lululemon rode on the back of yoga's increased popularity, particularly among women. After becoming a public company in July 2007, shares rose as high as $55 in October 2007. However, a New York Times article in November 2007 claimed that tests showed that Lululemon's VitaSea clothing line, which the company said was made with seaweed, showed "no significant difference in mineral levels between the VitaSea fabric and cotton T-shirts."

Combined with the effects of the recession, shares of Lululemon fell below $5 in early 2009 before making an astounding comeback. Shares of Lululemon hit an all-time high of $74 last month.

In December, Credit Suisse analyst Omar Saad initiated coverage of Lululemon with an "outperform" rating and $85 price target, despite the lofty valuation of the stock. Saad said Lululemon could become the next Coach ( COH).

"We have not seen a brand excite and attract the female consumer to this extent since Coach in the early 2000s," Saad wrote. "Women's has always been one of the toughest categories to generate consistent results, and we have witnessed countless women's fashion companies rise and fall over the past decade. However, it seems Lululemon has discovered the elusive formula to unlock the mystery of what woman want to wear and how they want to buy it."

Krispy Kreme Doughnuts ( KKD)

Company Profile: Krispy Kreme Doughnuts, as the name implies, sells doughnuts and related items through company-owned stores.

Current Share Price: $7.04 (Jan. 6)

2010 Share Price Gain: 134%

Comeback Story: In April 2000, Krispy Kreme went public, touting increased profits due to the popularity of its glazed doughnuts with consumers. The rapid expansion carried the company for a few years until the stock collapsed in 2004, falling from $40 to $12. In 2005, CEO Scott Livengood was removed from the job after the Securities and Exchange Commission probed Krispy Kreme for alleged improper accounting. Livengood denied these claims, instead attributing the company's decline in profits to another fad: the low-carb craze.

However, Livengood was slapped with shareholder lawsuits following accusations that he and the company were involved in self-dealing. Shareholders alleged that Krispy Kreme paid a premium to acquire a franchise that Livengood's ex-wife partially owned.

"There was a real faddish time with Krispy Kreme, and the company had to restructure to pay off lawsuits," says Hodges. whose Hodges Small Cap Fund holds a position in Krispy Kreme as of Sept. 30. "But they had a turnaround expert come in and re-establish the business. They closed unprofitable stores and returned to a more realistic base of what the doughnut business can make."

"It's not hugely profitable, but now they're making money," Hodges adds. "Those doughnuts will never be the craze it was, but people are going to continue to eat doughnuts."

Deckers Outdoor ( DECK)

Company Profile: Deckers Outdoor designs and sells footwear and accessories, including the popular Ugg brand.

Current Share Price: $80.65 (Jan. 6)

2010 Share Price Gain: 144%

Comeback Story: Deckers Outdoor went public in 1993 and shares remained below the $5 mark until late 2003, when demand for its line of Ugg boots skyrocketed. Shares ballooned to $50 by the end of 2007 but plunged to less than $15 during the height of the financial crisis in early 2009. By 2008, inventory levels built up, helping to precipitate the stock's decline. The Ugg boots also faced a consumer backlash. Pamela Anderson, once a celebrity endorser of the product, denounced Ugg boots after realizing they were made from animal skin. Additionally, critics labeled the boots as "ugly."

Despite these criticisms, the boots continue to sell, helping to prop up Deckers Outdoor share price. The stock high an all-time high of $87.88 in December.

"As much as I thought Ugg were a fad, they didn't totally disappear," says Michael Benoit, equity analyst at Chicago-based Talon Asset Management. "Deckers is a case where there's something to it. I would say it's a real business, it has a real brand and it's a valuable asset. The Ugg brand is worth a lot. There's real cash flow with no debt."

Jones Soda ( JSDA)

Company Profile: Jones Soda produces and distributes a range of premium beverages and related products in the U.S. and Canada.

Current Share Price: $1.23 (Jan. 6)

2010 Share Price Gain: 153%

Comeback Story: Jones Soda initially gained popularity thanks to an offering of unusual flavors of soda, including blue bubble gum, red apple and crushed melon. The company boasted its strong distribution network, as its beverages were available in Wal-Mart ( WMT), Starbucks ( SBUX), Target ( TGT) and Safeway ( SWY).

The popularity of Jones Soda pushed its stock to nearly $30 in early 2007, although an epic collapse dropped the share price to 30 cents by the end of 2008. Making matters worse, the company accepted a take-under deal from fellow beverage producer Reed's ( REED) in March 2010. The deal, which valued shares of Jones Soda at roughly 37 cents, was later scrapped, and a series of retail deals with Wal-Mart and Target helped the stock rebound modestly.

Sirius XM Radio ( SIRI)

Company Profile: Sirius XM provides music and talk radio entertainment through satellite transmissions.

Current Share Price: $1.65 (Jan. 6)

2010 Share Price Gain: 179%

Comeback Story: Sirius XM is often described as a "cult stock," due to the large following of individual investors in the company. Sirius was formerly known as Satellite CD Radio, which went public in 1994, trading around $4. The stock had an eye-popping run in the late 1990s, climbing above $60 in early 2000. But as the tech bubble burst, so did Sirius shares, plunging below $3 in late 2001. By late 2004, Sirius installed media veteran Mel Karmazin as CEO and announced the signing of Howard Stern, news that pushed Sirius shares close to $8.

Sirius and XM Satellite Radio were in a heated competition for talk radio personalities and sports broadcasting before eventually merging in 2008, more than a year after initially announcing the merger. Subscriber losses and bankruptcy fears dropped Sirius XM shares to 5 cents before Liberty Media took a stake in the company. Cost-cutting and rapid improvement in the U.S. auto industry helped Sirius XM shares roar back, as the stock now trades close to its 52-week high of $1.74.

"They're starting to be cash flow positive, which is a good sign," says Wilsey. "But I still wouldn't buy the stock yet, even though I like the product, because they're still not making money and I still have concerns about replacements. Just because I have it in my car doesn't make it a good investment."

Michael Benoit, equity analyst at Talon Asset Management, also makes note of the challenges Sirius XM still faces. "It's a little tougher here. They do have a unique product and replicating what they do is very difficult. There are replacements, but Sirius XM has a lot of talent. There's only one Howard Stern. But the difference is the leverage factor, which is going to put some pressure on the company. They have high fixed costs. It would be different if they had no debt, and it was a cash-rich business."

Crocs ( CROX)

Company Profile: Crocs designs and markets consumer products, mainly casual & athletic shoes & shoe charms, from specialty resins referred to as Croslite.

Current Share Price: $17.19 (Jan. 6)

2010 Share Price Gain: 186%

Comeback Story: Crocs was poised to be the ultimate fashion fad of the 2000s, with the contempt for the footwear rivaling the evangelical following Crocs shoes garnered. After going public in 2006 for roughly $17, Crocs shares jumped to nearly $70 in October 2007 during the fever pitch of the shoes' popularity. However, the retail environment wasn't friendly enough to Crocs, forcing the company to slash revenue guidance. After issuing lower-than-expected revenue and profit expectations in October 2007, Crocs shares dropped 30% in one trading session.

By early 2009, Crocs was a penny stock. However, shares have rallied back to a 52-week high of $19.54 thanks to analyst optimism. For example, Sterne Agee analysts in October said they anticipate Crocs' wholesale revenue will grow at a double-digit percentage pace for at least the next two years.

"It's starting to make sense to go back into Crocs. They seem to have turned the corner from before," Wilsey says. "The debt to equity is only 0.9. The company has no debt and a lot in cash and short-term investments. It was an educated risk because the company isn't going into bankruptcy."

Michael Corbett, manager of the Perritt Emerging Opportunities Fund, notes that Crocs had similar characteristics to Heelys. "It was so far below book value that you had to think 'Are they actually going to burn through all the cash and go bankrupt?' It's the opposite of greed. There was fear it was going under. Is the fad going to come back? Probably not. But it's not going to zero."

Hodges says Crocs was doing $240 million in sales per quarter, totaling almost a $1 billion sales business, but the backlash against the product proved to be too great for a time.

"There was a backlash to the popularity and Crocs became a punch line," Hodges says. "I think I saw a skit on Saturday Night Live about Crocs. It went from one side to the other over the period of a year. But we realized that while they may not sell $1 billion of shoes every year, the underlying business has international opportunities and a bunch of new products."

-- Written by Robert Holmes in Boston.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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