SAC Capital Advisors, the hedge fund run by legendary investor Stephen A. Cohen, has raised its stake in Coinstar (NASDAQ:CSTR) to 6.5% from 1.2%.

Should you follow Cohen into the stock?

The company has an interesting history — having started off as a way to make loose change useful for people visiting the supermarket.  But that part of the business, where consumers can convert their coin to cash or stored value products at coin-counting self-service kiosks, is no longer Coinstar’s dominant business.

Now its core service is automated retail, where consumers can rent or purchase DVDs from self-service kiosks. At the end of 2010, Coinstar had 30,200 DVD kiosks in 26,100 locations and 18,900 coin-counting kiosks in 18,700 locations in supermarkets, drug stores, mass merchants, financial institutions, convenience stores, and restaurants

Coinstar’s stock hasn’t fared too well in 2011 – dropping more than 2% after cutting fourth quarter-revenue growth estimates in January.

And meeting expectations for the first quarter of 2011 could be tough.  That’s because Coinstar is trying to follow a plethora of competitors like Netflix (NASDAQ:NFLX) in making the transition from DVDs to online video streaming.  And with all the competition it faces already, Coinstar could be facing a steep wall of investment in its digital strategy that its profits will not allow it to surmount.

Coinstar’s Redbox movie-vending machines face increasing competition as companies such as Time Warner (NYSE:TWX), Netflix, Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN) and others launch on-demand movies. Netflix expects Dish Network (NASDAQ:DISH) to use the Blockbuster assets that Dish is buying out of bankruptcy to launch another, Blockbuster-branded streaming-video service, which would add yet another competitor.

So what is a hedge fund honcho seeing that makes him want to own so much more Coinstar stock? It could be that he believes earnings forecasts for Coinstar suggesting that the stock is cheap.  As I look at it, on a price-to-earnings-to-growth (PEG) basis – where 1.0 is reasonably valued, Coinstar’s PEG of 0.9 — with a P/E of 24.9 on 25.9% earnings growth to $3.47 a share in 2012 — looks pretty reasonable.

SAC’s investment could be a well-deserved vote of confidence.  But much of its future depends on how well Coinstar can manage the move to digital streaming so that its investment in digital content isn’t wasted amid a wave of competitors who force Coinstar to avoid raising prices enough to cover its costs.

Peter Cohan has no financial interest in the securities mentioned.