The key to finding a winning investment involves a degree of far-sightedness. You need to anticipate what a company’s financial results may look like 12-18 months from now, even as Wall Street analysts base their projections on the next quarter’s results. The key is to get involved with the stock before Wall Street finally turns bullish on a company’s prospects.

Just as important, you need to find a stock that holds value simply based on present results as well. That means a clear line of support undergirding the stock price. Even if patience is required for the investment thesis to play out, don’t run the risk of losing money while being patient.

That’s precisely the backdrop in place for toy maker Hasbro (NYSE: HAS). The company’s recent results have been just so-so, and shares are now down in the low $30s after hitting nearly $50 in late 2010. That swoon reflects recent anemic growth in sales and profits, but ignores potentially solid profit growth that lies ahead. Management has been laying the foundation for growth during the past year or two, and has cautioned that a payoff will take time. But most investors are in no mood to look ahead; they’re simply looking at current results.

A myopic view like that is exactly what I look for in a candidate for my $100,000 Real-Money Portfolio.

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The current view is indeed sobering. Hasbro had a lackluster holiday selling season and just pre-announced fourth quarter sales of $1.33 billion, below the $1.37 billion consensus estimate. That works out to just 3% annual sales growth. Investors had been expecting earnings per share of around $1.15, but that figure now looks likely to be closer to $1. This would represent zero profit growth from a year ago.

Before I explain why growth should resume at an impressive rate, starting later in 2012, let’s take a look at the past six years (along with my 2012 and 2013 forecasts).
 


Hasbro’s management has delivered ever-improving results, though not always in a consistent fashion. Per-share profits grew at fast clip from 2005 to 2007, though profits have grown in a more stutter-step fashion since then, as you can see in the t. That’s partially a function of hot toys and games hitting their stride in certain years. In some respects, profit growth becomes constrained from its regular pace when management chooses to make investments in the present time that will pay off in the future.

Management realized that toys and games don’t always bring great margins, so they moved Hasbro into the licensing business as well, letting Hollywood studios, fast-food franchises and others use the company’s key properties in exchange for high-margin licensing fees. That’s why net profit margins have risen from about 6% in 2005 to about 9% in 2011.

The good news: a series of fresh new movies based on Hasbro characters will be released in coming quarters, which is why net margins can actually move toward the 9.5% mark by 2013. Feature films that tie into toys and games such as Battleship, Stretch Armstrong, Monopoly, Ouija, Clue, along with a GI Joe sequel, have been discussed or are already in production. Most of those films, assuming they receive the green light, will be released in 2012 and 2013.

Still, the company is in investment mode. Recent bottom-line results have been negatively impacted by a decision to invest $300 million in a new kid’s TV network known as “The Hub,” which was launched in late 2010 in partnership with Discovery Communications (Nasdaq: DISCA). The TV investment has been a drag on profits but should soon start to bolster them. The network has been steadily gaining viewership at the expense of rivals like Nickelodeon, the Disney channel and the Cartoon Network.

Fourth-quarter ratings haven’t been released yet, but The Hub saw a 24% jump in viewership in the third quarter compared with a year earlier. That not only translates into higher ad rates, but also greater visibility for all of the Hasbro toys and games that are featured on the network.

Yet that’s not why I like this stock. Instead, it is Hasbro’s prodigious levels of cash flow that create the real, tangible value. From 2006 through 2010, Hasbro generated a cumulative $1.1 billion in free cash flow. 

The recent slowdown in sales growth hasn’t stopped the company from a key ongoing initiative: share buybacks. The share count has fallen from 196 million in 2005 to a recent 137 million, and that figure should fall further in 2012. The company is so convinced that its shares are undervalued that it borrowed $500 million in late 2010 to maintain lofty buybacks ever since.

Shares are a bargain now simply because Hasbro has hit another speed bump on its path to long-term growth. Fourth-quarter results (which were pre-announced earlier this week and will be discussed by management in greater detail on Feb. 6) are surely disappointing. The fact that EPS are growing at less than 10% right now, despite the ongoing buybacks, makes it look as if Hasbro has stalled out. Management concedes that even as international sales continue to grow at a fast pace, U.S. sales have slipped back.

The upcoming conference call will carry a lot of detail regarding plans to re-invigorate the U.S. toy business, along with a deeper discussion of the company’s myriad licensing initiatives, especially in the area of feature films. At that point, investors will get a better read on the higher-margin licensing streams yet to come.

I remain convinced that Hasbro is in the midst of another pause before growth resumes. The company owns a treasure trove of valuable characters and games, many of which are just now penetrating the international market. Here at home, the weak economy has dampened results for all games makers, including rival Mattel (NYSE: MAT). As unemployment rates come down and consumers feel more confident, spending on games and toys should pick up.

The Downside Protection –> It’s hard to see shares falling much below current levels in the low $30s. The stock is supported by a price-to-earnings (P/E) ratio of around 11 (which is 30% below the S&P 500’s multiple), a 3.8% dividend yield, an ongoing share buyback and still-strong free cash flow. Both the company (with the buybacks) and income-seeking investors would likely step in as buyers if shares fell below $30.

Upside Triggers –> I’m not expecting a fast rebound in the toys and games segment any time soon, I but think the Street is underestimating the licensing end of the business. Simply put, Hasbro’s bottom-line should start to post more robust year-over-year EPS comparisons later this year, even as the top-line results grow more slowly.

Moreover, The Hub TV network has been a drag on earnings thus far, but should be a money-maker in 2012 and beyond. Analysts’ assumptions of very weak profit growth in 2012 appear to ignore the likely $0.15 to $0.25 swing in profitability that the TV network represents.

Action to Take –> Still, it’s premature to commit a lot of funds to this stock until it either falls even further into value territory or the 2013 profit growth scenario comes into sharper focus (which may happen as soon as this spring). So I’m starting off this holding with a modest 100-share position, equating to roughly $3,300. I will purchase these shares 48 hours after you have had a chance to do so.

I expect Hasbro to eventually constitute a major part of my portfolio, but am in no hurry, either. This starter position helps me (and my readers) to better focus on the slow profit turnaround that I anticipate later in 2012 and into 2013.

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