This article is a reprint of my 5 August 2008 RealMoney column.

With consumers under duress, it is likely wise to avoid consumer-discretionary stocks, especially those in companies that sell goods that cost thousands of dollars. But few fortunes are made by following conventional logic, and often investors must look for unconventional opportunities that may be unfairly priced. I think Polaris Industries (PII) may be one such opportunity.

Polaris make all-terrain vehicles (ATVs), snowmobiles and motorcycles and markets them — together with related replacement parts, garments and accessories — through dealers and distributors principally located in the United States, Canada and Europe. Its primary competitors include Arctic Cat (ACAT) , Bombardier and Honda Motors (HMC - Annual Report) .

Polaris shares are down 20% over the last year, as investors appear to expect a slowdown in sales and profits. Yet those metrics are rising. Second-quarter sales were up 21%, and earnings were up 16% compared to last year. The earnings beat the consensus estimate by 4 cents, and the company raised its full-year guidance by a similar amount.

Polaris’ strength is being driven by sales of ATVs, which account for two-thirds of total revenue. In particular, the company’s popular Ranger and RZR brands of multi-passenger “side-by-side” ATVs have given the company the top market share in that category. Polaris grew sales of its side-by-sides by more than 50% in the latest quarter, even as the overall ATV industry has been essentially flat. On the recent conference call, investors heard that channel checks indicate continued supply shortages. With the hot side-by-side ATVs in short supply, moderating sales would simply bring supply and demand into balance.

Over the last 12 months, Polaris generated $140 million in free cash flow, measured as cash flow from operating activity less capital expenditures. At 9.8% of the company’s market capitalization, the cash-flow yield represents a healthy premium to the yield on five-year Treasuries. The company has been using its free cash flow to pay out a healthy dividend (the yield is now 3.5%, itself comparable to the Treasury yield) and to buy back shares. From nearly 44 million diluted shares in 2005, the share count has been reduced by nearly a quarter, to less than 34 million today.

Analysts expect the company to grow earnings by 12% per year over the next three to five years, a rate that is well below the rate that can be sustained given the company’s high returns on equity. I think the estimate is a reasonable one. If growth remains in double-digits, as I suspect, then investors won’t continue to require such a high free-cash-flow yield from the stock. Even at a 7% yield, the risk premium over Treasuries would be 100%, a level often cited by value investors as a target premium.

If free cash flow per share rose by 12% next year, and the shares were priced for a 7% free-cash-flow yield, the resulting $65 share price would represent nearly a 48% premium from the current level. Even if it took five years for the valuation to adjust to a 7% yield, total returns would be 15%-20% annually. With that kind of return, I’d be willing to wait for the valuation to correct.

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned in this column.

In Monday’s video roundup “Best Trades Now: Financials, Medical Suppliers & More” which one is a 10-day earnings reactor?

“They’re [Harley Davidson (HOG)] what we consider a ten-day earnings reactor, meaning within ten days we’re going to see the most price movement for this company…

Full disclosure: In “Stocks Your Dad Would Love,” which of Brent Wilsey’s picks is in his portfolio?

Disclosure:

Brent Wilsey owns shares of Harley-Davidson in his portfolio and those of his family and clients.

Can’t say I agree with that one. I wrote a bearish piece on Harley Davidson (HOG) back in March.

Earnings at toymaker Hasbro (HAS)  rose 14 percent in the first quarter on growth in brands such as Transformers and Littlest Pet Shop. The results beat expectations and drove its shares up almost 10 percent in morning trading.

Hasbro had recently shown up on my radar screen, and has several things going for it:

• 2007 free cash flow of $510 million, good for a 10.4% free cash flow yield based on the current market value. Even using the average free cash flow of the last three years, the yield is more than 8%.
• High earnings quality, with the difference between cash- and accounting-based earnings (as measured by the accrual ratio) less than 5%.
• High earnings momentum, with rising estimates for the current and next fiscal years.

The stock has had a heckuva run since the January lows, but on a 12-month basis has gone essentially nowhere. It looks a bit overextended to me right now, but would probably look interesting on a pullback to the 50 day moving average - which is currently $28.17 and rising.

Disclosure: At time of publication, William Trent has no position in the companies mentioned.

My latest column is up at RealMoney. Although it is cheap, I don’t think Harley Davidson (HOG) is cheap enough. In summary:

It would be one thing if earnings were growing 12% per year, as they have for the last five years. In that case, investors could expect 15% annual returns. But I don’t think the growth will be even close to that rate, or to the 11% consensus growth estimate.

If the company does manage to earn $3.94 in 2009, it will have finally regained the levels it earned in 2006, and would then have a five-year earnings compound annual growth rate (CAGR) of 5.5%. I think that is a more reasonable growth estimate to use, and plugging that in implies a decent but not great expected return of 8.5%. If I hope to earn double-digit returns, I’d expect a share price no higher than $29 per share next year, or about $26 a share today.

Taking a free cash flow approach to valuation, Harley generated $556 million in free cash flow in 2007, for a 6.2% yield against the current market cap. That’s a nice yield, but I’ve seen quite a few names with similar or higher yields and more attractive growth prospects. In order to generate a double-digit free cash flow yield, the price would have to drop to $23 a share.

Disclosure: William Trent has no financial position in Harley Davidson (HOG)

I am proud to host this edition of the Festival of Stocks. Since you are here for some stock picks, let’s get to them!

Rock Your Stock rang in first with Callaway (ELY) is Hot. He says the stock is on a tear and has the fundamentals to back it up.

Rick Casterline at Once More Unto the Breach figures he can sleep when he dies. No way is he going to do it during day 3 of the Berkshire Hathaway Annual Meeting.

Average Joe at Investment Jungle weighs in with a review of Small Cap Watch List (Track at Marketocracy) member First Regional Bancorp (FRGB). Joe and I have frequently been on the same investment page.

Project Stocks submitted Beat the Market With Only 15 Minutes of Work Each Year. The idea is to buy each year’s top performing fund and hold it for a year. Seems simplistic, but it actually has some support from recent academic research.

Neural Market Trends wonders about the effect of financial asteroids on market trends.

Fiscal Times tells us the stocks Business Week ranks as most innovative tend to perform better.

Big Cajun Man has found a real lu-lu.

TJP at Investor Trip explains what he missed when he first got Sirius (SIRI).

Trader’s Narrative is calling a bubble… in China.

Self Investors outlines a successful day trade in Force Protection (FRPT).

Silicon Valley Blogger offers 5 tips for evaluating your portfolio.

George at Fat Pitch Financials presents his five favorite ways to hack into the web’s resources for investors. I downloaded the Excel add-in and am looking forward to trying it out.

Sox First outlines what went wrong with the planned private equity takeover of Qantas.

And what the heck? I’ll toot my own horn by presenting my take on United Industrial Corp. (UIC).

Mid Cap Watch List (Track at Marketocracy) member Pool Corporation (POOL) today reported record net sales for the first quarter of 2007 and affirmed its projected 2007 diluted earnings per share guidance.

Earnings for the first quarter of 2007 were $0.03 per diluted share on net income of $1.4 million, compared to $0.12 per diluted share on net income of $6.4 million in 2006. The decrease includes the impact of approximately $0.03 per diluted share related to incremental operating expenses for the 17 new sales centers opened in 2006 and the 7 new sales centers opened in the first quarter of 2007.

The results for the seasonally slow period compared with analyst estimates of $0.07 per share. For the full year, however, management believes things will be just fine:

“We realized a 4% increase in base business sales despite a tough comparison to the 15% base business sales growth in the first quarter of 2006 and unfavorable weather conditions during the first quarter of 2007. As we move into the heart of the pool season, we are prepared to take advantage of the numerous opportunities in the young swimming pool industry and we expect to deliver another year of solid results. Consistent with our prior guidance, we project that 2007 earnings per share will be in the range of $2.00 to $2.10 per diluted share,” commented Manuel Perez de la Mesa, President and CEO.

Consensus estimates of $2.00 were at the low end of the new guidance. The news cheered up investors who might have been expecting the housing slowdown to impact sales. The shares are rallying on the news.

Unfortunately we didn’t reverse our bullish position when we noticed the odd Oracle/Plantronics lovefest.  It nailed Oracle’s (ORCL) miss, and we should have sold Plantronics (PLT) on superstition alone. Instead, we are left with the thin gruel of a partnership with Quicksilve (ZQK):

The new collection integrates Quicksilver’s outdoor sports apparel with Bluetooth-equipped mobile phones, iPods and MP3 players. The goal is to make the components wireless to make use in active settings, such as skiing, easier.

Earth to Plantronics (company management apparently accompanied their headset to the moon): any skier who needs Bluetooth clothing probably already bought a pair of Oakley (OO) Thumps. And no, investors were not so enamored with your breathlessly announced deal to ignore your earnings report. Revenues of $215.4 million beat the $210 consensus but were down from $222.5 million in the third quarter of fiscal 2006. Thanks again (sarcasm) for spending your cash flow on Altec Lansing. The company’s guidance also came in well below analyst expectations.
Given the cash flow disclosure provided, it looks like the company produced about $25 million in free cash flow during calendar 2006, meaning that its $900 million enterprise value gives it a rich valuation of more than 35x free cash flow, and the conference call discussion indicated little opportunity for significant improvement in the coming year.

Disclosure: Long PLT at time of publication.

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Summary: The housing market is slowing for sure, and the low-end retail woes are spreading to high-end retailers like Best Buy (Plasma TV spending fears.) Some of the high-end toys like boats and snowmobiles are having a tough go, but it seems we’re still willing to pay up for a good night’s sleep.
Watch List Companies

Other News

Mattel (MAT) posted an upside surprise due to stronger than expected Barbie sales (take that, Bratz!) as well as promotional tie-ins with Cars and Superman. The company reported second-quarter net income of $37.4 million, or 10 cents per share, compared with a year-earlier loss of $94 million, or 23 cents per share. Excluding items, earnings rose to 8 cents per share from 5 cents. Analysts on average had been expecting 4 cents, according to Reuters Estimates. Revenue rose 8 percent to $957.7 million, surpassing analysts’ expectations of $922.95 million.

Harley Davidson’s (HDI) quarterly earnings rose 2.5 percent and it was on track to meet its 2006 shipments. Harley said its second-quarter net profit rose 2.5 percent to $243.4 million, or 91 cents a share, from $237.4 million, or 84 cents a share during the period last year, meeting the average estimate. Revenue rose 3.3 percent to $1.38 billion., sending shares higher in premarket trading. The 2006 outlook bucked a trend of disappointing results and scaled-back expectations from U.S. recreational vehicle makers, which have been laboring under rising interest rates and energy prices, and a slowing housing market.

Previously, several U.S. companies selling pricey toys for adults — including boatmaker Brunswick Corp. (BC), snowmobile manufacturer Polaris Industries Inc. (PII), and RV maker Fleetwood Enterprises (FLE), — reported lower quarterly earnings, saying economic headwinds were keeping consumers out of showrooms.

Coca-Cola Co. (KO) posted better-than-expected earnings boosted by its PowerAde sports drink and Dasani bottled water brands. Second-quarter profits were $1.84 billion, or 78 cents a share, up from $1.72 billion, or 72 cents a share, a year earlier. Excluding a gain from the sale of shares in the initial public offering of its Turkish bottler, Coke reported earnings of 74 cents, 2 cents ahead of Wall Street expectations, according to Reuters Estimates. In the past year, Coke launched a flurry of brands such as coffee-infused soda Coke Blak and energy drink Vault and extended flavors of existing brands like Dasani flavored water, to cash in on the growth in the energy drinks (led by Watch List member Hansens Natural [HANS]) and water segments.