Avoid This Weak Consumer Stock, Buy These 2 Instead

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Now that the Senate has reached an agreement on taxes in 89-8 vote, investors are likely to start focusing on the upside from here. Several analysts have already forecasted for double-digit capital gains in 2013, so I encourage investing in the braoder macro trends. As consumer incomes rise from greater confidence, greater expenditures will flow into the toy and beauty categories. While it is generally a safe strategy to broadly diversify, if you want higher returns, you need to either go with the momentum or beaten down stocks. Below, I review several that fit the bill.

Why You Should Play Mattel (NASDAQ: MAT)

The well-known maker of Barbie dolls has delivered fantastic returns over the last 2 years. It is now up 40% from its 52-week low and around its 52-week high with no end in sight. At a respective 15.2x and 13.2x past and forward earnings, the company is also cheap enough to "buy" for double-digit ROA, ROE, and ROI. With a dividend yield of 3.4% and growing, Mattel is also a very safe stock for passive income investors.

Although the company is not undervalued at a 10% discount rate and its current multiple, momentum and secular trends are driving the stock in the right direction. Parents are more apt to buy their children toys during a full recovery than they are during a recession. And for the 5-year period surrounding the recession, Mattel still grew EPS by 7.3% annually. With gross margins expanding to 52.9%, the toy maker is also capable of generating a greater amount of free cash flow per each sale than it has in the past. Management continues to execute across all major brand categories, and has positioned Mattel for strong bottom-line momentum through turning around Fisher-Price.

It should further be noted that Mattel is actually gaining share in the markets it is pursuing. Penetration in the United States and European markets, combined with improving retail inventory, all point to a secure future. Penetration in emerging markets, such as China and India, point to a high-growth future.

Avoid Avon Product (NYSE: AVP), Buy Estee Lauder (NYSE: EL)

Despite shaking up the board through booting the CEO, the direct seller of beauty products still has many road bumps ahead. Since rejecting the buyout bid, the stock has fallen 37.3% from its 52-week high at around $23. At a 15.4x forward earnings right now, the company is already quite expensive. Shareholders might be tempted to ask themselves, in my view, whether the board breached their fiduciary duty.

With forecasts for little to no EPS growth over the next 5 years, Avon is in a conundrum. On one hand, it has an impressive brand portfolio that has delivered strong execution in Brazil. On the other hand, a series of managerial missteps have put the company meaningfully behind the competition.

One alternative that the Street is bullish on is Estee Lauder. Though the stock trades at 28x past earnings, it commands this premium due to its high projected growth rate. Analysts forecast the company's EPS growing 13.9% annually over the next 5 years. In my view, this overly bearish given that 14.9% was achieved over the past 5 years when the economy was in a recession.

Assuming the company meets expectations, it will generate 2016 EPS of $5.48. At a 17x multiple, this translates to a future stock value of $93.16. That's a strong enough upside that accounts for bearish growth and multiples compression to justify an investment.

So, the best way to play the improved fiscal situation is to invest in a basket of momentum and beaten down stocks. While the former will provide you with a nice stream of free cash flow (and Mattel has become increasingly generous with its dividend distribution), the latter could help you outperform. Either way, both are skewed more towards reward than risk, so my recommendation provides an optimal strategy for those looking to track the broader market with slightly greater upside.

TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Mattel. Motley Fool newsletter services recommend Mattel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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