If you are looking to diversify your portfolio by investing in the toy industry, you should consider Mattel (Nasdaq:MAT) and, depending on market conditions, LeapFrog (NYSE:LF).
The Industry
The toy industry is highly correlated with market trends. Mattel has a beta of 0.92 and Leap Frog's beta is 2.14. Thus, with an increasing market return, both companies may follow the trend, and Leap Frog could even outperform the market. With the outlook of the market getting better, I think it is worthwhile to take a position in this sensitive industry.

In manufacturing, economies of scale is always an important factor. Mattel is the biggest company in the toy industry, with a market cap of 10.54 billion. The company's net income in 2011 was $769 million. Mattel's gross margin of 50.20% is higher than that of its peers like Hasbro (Nasdaq:HAS) and JAKK (Nasdaq:JAKK). Hasbro, Mattel's main competitor, has a gross margin of 48.4% while JAKK's is 31.29%. Mattel's operating margin of 17% is also higher than that of Hasbro and JAKK. Hasbro's operating margin is almost 3% lower than Mattel and JAKK's is less than 3%. Looking at P/E ratios, Mattel's P/E is in line with that of the industry's average of 14 while JAKK's P/E is above 55.

See: Analyzing Operating Margins.

LeapFrog is a small cap and its operating margin of 5.28% is much less than Mattel and Hasbro because of the lack of economies of scale. However, LeapFrog has shown significant growth in revenue during these years. From 2009 to 2010, the company's net income improved greatly from a loss of $2.7 million to a $4.9 million profit, and its net income increased by more than 300% to $19.9 million in 2011. LeapFrog has a P/E ratio of 27.5, well above the industry average. With a positive market outlook and a huge potential, the company's stock is worth buying.

Cash and Dividends over the Years
Mattel's current dividend yield is 3.9%, which is pretty decent. Although LeapFrog does not offer dividends yet, it's still a growing company and has only been public for 10 years. I think for a growing company like Leap Frog, it's more meaningful to look at its cash position. LeapFrog's cash and cash equivalents have grown from $19.5 million in 2010 to $71.9 million in 2011, which could indicate an availability of extra cash to invest in new projects. Moreover, LeapFrog's inventory reduction from $47.5 million in 2010 to $34.3 million in 2011 might be due to a current increase in demand.

See: Measuring Company Efficiency.

Technical Analysis
Mattel's RSI (14 days) value is at 32 and LeapFrog's RSI is 54. An RSI value below 70 is an indication that the stock is not overbought. Mattel's RSI, which is almost at the 30 benchmark, is an indication that the stock is likely to be undervalued. In addition, both companies have shown a clear upward trend since 2008 with no clear resistance.

See: An Introduction to the Relative Strength Index.

Bottom Line
Based on current market conditions, Mattel would be a great company to invest in, and now is a good time to buy. LeapFrog might also be worth investing in, but it may be a bit risky given its high beta. Investors' decision to buy LeapFrog should depend on their level of risk adverseness and confidence in the market's recovery.

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At the time of writing, Alexandra Yan did not own shares in any of the companies mentioned in this article.

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