Jakks Pacific: Don't Bottom Fish Here

NEW YORK ( TheStreet) -- As value investors, we tend to want to buy companies on the cheap. We're always on the lookout for the veritable "50-cent dollar". That sometimes entails buying what no one else wants -- companies that are beaten up more than they deserve.

When there is a mass exodus form a particular stock, and the selling pressure decimates the price, the objective is to determine whether the market has overreacted.

Whether you believe in market efficiency or not, there are countless examples where the market has gotten it wrong. Frankly, I am a big fan of market inefficiency for that very reason. It can create wonderful buying opportunities at times.

But just because a stock loses a rather large percentage of its value in a given trading day does not make it a screaming buy. There are situations that are so ugly that even the bottom fishers and garbage fishers should stay away, at least until the dust settles. Often, such situations arise from a terrible earnings report that has longer-term implications.

It's easy to fall into the mentality that a 20%, 30% or 40% decline in one day in a stock is an overreaction until you consider that maybe the market was overvaluing the stock before the selloff.

One name I've been watching for some time is toy company Jakks Pacific ( JAKK). The company has seen sales fall for four straight years, but its rather clean balance sheet, ample cash, and somewhat recently established dividend have made it attractive as a potential value play.

In fact, back in September of 2011, Oaktree Capital Management (Howard Marks' firm) made an unsolicited $20 takeover bid for the company.

Jakks rejected the offer, and then another activist group got involved which led to an expansion of the company's board of directors. The company ultimately bought back 15% of outstanding shares in a self tender offer at $20 a share, but it has been downhill from there.

On Wednesday night, the company issued an awful second-quarter earnings report. Revenue, which fell nearly 27% to $106.23 million, was well below the $147.74 million consensus estimate. The company lost $2.14 per share for the quarter, well below consensus estimates for a loss of 5 cents. Although this is a small company, there are seven analysts following it, so this was quite a surprise.

What's more, the company suspended its 7-cent quarterly dividend. Cash fell from $165 million the previous quarter to about $70 million. Much of that drop was due to repayment of short-term debt, but it all but eliminated one factor that made the company somewhat attractive. Book value per share fell from $8.11 last quarter to $5.92. Ouch!

Of course, on Thursday the stock got hammered, falling nearly 40% to $7, which is 65% less than Oaktree's takeover price. It was downright eye-opening: one of the uglier quarters I've seen from the smaller names that I've been watching in quite awhile .

JAKK Chart JAKK data by YCharts

The company did issue guidance for 2014, calling for revenue between $694 million to $700 million and earnings per share of 63 cents to 68 cents. Those numbers don't sound too bad, if they're achievable. Although I typically don't focus on a single quarter, Jakks' numbers were so bad that you have to wonder where the company really stands at this point. In the best of times, the toy business is very competitive and difficult.

Despite the 40% drop, JAKKs is a bit too uncertain, even for me at this point.

At the time of publication, Heller had no positions in stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
Jonathan Heller, CFA, is president of KEJ Financial Advisors, his fee-only financial planning company. Jon spent 17 years at Bloomberg Financial Markets in various roles, from 1989 until 2005. He ran Bloomberg's Equity Fundamental Research Department from 1994 until 1998, when he assumed responsibility for Bloomberg's Equity Data Research Department. In 2001, he joined Bloomberg's Publishing group as senior markets editor and writer for Bloomberg Personal Finance Magazine, and an associate editor and contributor for Bloomberg Markets Magazine. In 2005, he joined SEI Investments as director of investment communications within SEI's Investment Management Unit.

Jon is also the founder of the Cheap Stocks Web site, a site dedicated to deep-value investing. He has an undergraduate degree from Grove City College and an MBA from Rider University, where he has also served on the adjunct faculty; he is also a CFA charter holder.