Gerrick Johnson's title is Vice President, Equity Research Toys for BMO Capital Markets.  But here is what you really need to know about Gerrick Johnson:  He has the ability to move the stock markets.  Sought out by the Wall Street Journal, the New York Times, Forbes and other serious sources of business information, Gerrick provides his studied insights on publicly held toy companies.  Investors look to Gerrick to make determinations as whether to buy, sell or hold.

I thought it important to talk to Gerrick and find out how he does his job, what he thinks of the toy industry and maybe get a stock tip.  Here is my interview:

Richard:   What is BMO Capital Markets, what exactly do you do there and how do you do it? 

Gerrick: BMO Capital Markets is brokerage and investment banking arm of BMO Financial Group, and I am an equity research analyst covering the toy industry. 

In short, I provide investment ideas within the toy industry to institutional investors.  The product we provide to investors can be either stock recommendations, or value-added information that will help the investor make an investment decision.  Should our investor clients find our product useful or helpful, they will trade their position through our trading desk, where we earn a commission. 

All analysts approach their job differently.  For me, I focus primarily on anecdotal observations gleaned from many store visits, which we call "channel checks".  I visit major retailers to gauge overall shopping activity, demand for a product, promotion or clearance activity, shelf space changes, and other incremental pieces of information that would be helpful in the investment decision-making process.

Richard:  What are the publicly held toy companies and how does a company classify as publicly held? 

Gerrick:  A publicly held company is one that has publicly traded stock listed on one of the exchanges. The publicly-traded companies that I cover include Mattel, Hasbro, JAKKS Pacific, LeapFrog, RC2, Mega Brands, and Build-A-Bear Workshop. 

Richard:   What are you looking at when you make a buy, sell or hold recommendation? 

Gerrick: That is a good question, Richard, because many people mistakenly believe that a well-performing company must be a good stock to own.  That is usually true, but not always the case. When recommending a stock to buy we are looking for attractively valued stocks. We are also looking for companies that will perform better, in the future, than currently anticipated.  In this regard, incremental information is extremely valuable.  If a highly anticipated toy line does well, but not as well as lofty expectations, then the underlying toy stock can go down, even though the line and company may be doing well on an absolute basis.  This is especially if the valuation is also high.

Often, I am looking for areas where the market has the story wrong.  By focusing closely on product and in-store execution I believe I can often spot changes in trends, or new and incremental information before the rest of "The Street". 

If I am visiting stores frequently enough, hopefully I can find the highly anticipated line marked for clearance before anyone else. I will then be able to make my clients money by presenting a sell idea before any of my competitors. That is because, as you know, those markdowns will eventually hit the company's income statement in the form of lower revenues and margins than originally anticipated. 

Wall Street can be very reactionary, where investors react to reported earnings. Therefore, you can be much more successful by understanding the story and taking a position before those earnings come out.

Richard: How do you go about doing your analysis? 

Gerrick: First, we start off by creating an earnings model.  We model out the income, balance sheet, and cash flow statements, both historical numbers as well as our expectations for the future, usually the next two years out.  These models will be based on information from financial reports filed with the SEC, comments management has made on conference calls, discussions with people in the industry, and our own observations at retail. 

We then take those earnings expectations and use them as a yardstick to guage the current valuation- what kind of “multiple” the market is putting on those expected earnings. If the resultant valuation is low, it could be an opportunity to buy the stock. 

The next step is doing some sensitivity analysis to see where we could be wrong in our assumptions and estimates.  If it looks like our model may turn out to be conservative, with a better opportunity for the company to "beat" those expectations, then that is an added incentive to buy the stock. Combine that with a low valuation, and you could have a very compelling buy opportunity in that stock.

Richard:  How is the toy industry doing?  Are things looking up? 

Gerrick:

I think the industry is doing OK, but is clearly feeling the pinch from the current slowdown as well as higher costs of production.  Investors had flocked to the "defensive" toy stocks at the end of last year, thinking that toys would withstand the recession better than other industries.  The severity and suddenness of the economic decline created a lot of uncertainty leading up to the holiday season. Therefore, I think families cut back on everything across the board, including kids.  Toy company earnings suffered and 4Q results were well worse than what investors had expected. 

Looking forward, though, I think toys may be a better place to invest.  Despite the economic downturn, there is more certainty.  So parents know how much or how little they have to spend, and therefore know what to budget on their children. The idea that parents don’t scrimp on their kids should have more merit in 2009 than it did in the more uncertain times of 2008. 

Also, the 2009 assortments offered by toy companies should be much more appropriate for the environment than they were in 2008.  In the near-term, we still have fewer discretionary dollars to spend, pressures from retailer adjustments, and cost issues, so the industry will continue to feel the impact in a negative way.  However, I think toys may begin to perform better than other industries, and the stocks may as well. The market has had a bit of a run lately, so I think I would let the stocks get a little cheaper, though, before buying.

Richard:  Do you have a stock tip for the readers? 

Gerrick: I don’t feel comfortable giving specific stock recommendations, since they are meant for professional investors who we have a continual dialogue with. So my tip would be to give the max you can to your 401k and have an appropriate weighting of stock index funds and fixed income investments based on your age.