Tuesday, October 30, 2007

Is Select Comfort a "scary stock"?

This is a response to an article on the Motley Fool. I'd post it as a comment, but the site ate my post. (I think it filtered out everything after the '&' in "R&D", which is a pretty bogus behavior.)

First, operating profits are down because of increased marketing and R&D--other expense lines are down. Second, buybacks are good investments if the market is undervaluing shares, not because they raise EPS in the short-term. Third, the changes in capital structure are nearly riskless because of Select Comfort's massive and growing cash flows.

Ultimately, a lower stock price combined with a commitment to marketing, R&D, and share buybacks are very positive signs if you believe the company has a superior product. If the company's product turns out to be a fad or is overtaken by competitor copies or improvements, these moves hasten its eventual demise. The reason is that these changes are increasing the company's leverage. Small improvements will be magnified into big improvements and small declines will be magnified into big declines.

So the comparison with Tempur-Pedic is actually encouraging to Select Comfort investors. The Sleep Number bed shares more similarities to foam mattresses than traditional mattresses sold by other companies. In fact, some Sleep Number beds use similar foam to form the top layer over the air chambers. As far as price, Select Comfort offers additional features, such as firmness control, at nearly identical prices to Tempur-Pedic. (For instance, a 4000 Queen is $1,199.99 at Select Comfort and The Original Queen is $1,199 at Tempur-Pedic.) If compared to traditional beds, it's possible to buy a queen size for around $600, which is right in the sweet spot for quality mattresses.


Anonymous said...

Jon, I appreciate your post and hope that you are correct about Select Comfort.

The Motley Fool has lost what little credibility they had with me when they start bashing the very stock that was their top pick in Hidden Gems last year.

Anonymous said...

It seems like The Fool gains credibility for allowing all voices to be raised on stocks they recommend. Yes, it seems like they picked poorly (four times) in recommending this stock, but that seems a knock on their stock picking ability, not their credibility. I am truly baffled by all the comments on how this hurts their credibility ... would the posters rather have the fool continue to pump a stock it no longer believes in? Not let divergent opinions be expressed?

Jon Ericson said...

I don't think the Motley Fool has a credibility problem either. I picked Select Comfort independently of the Hidden Gems newsletter and I'm sitting on a large unrealized loss. But I think for the long term (five plus years), the original analysis will prove more correct than incorrect. The only piece missing is that Select Comfort turns out to be a cyclical stock, which doesn't work so well with the buy-and-hold approach.

The problem I have with the particular article I'm commenting on is that some of the facts are wrong or given undue weight. For instance, the fact that Sleep Number, and not Select Comfort, is the brand consumers know seems a totally meaningless criticism. Proctor and Gamble investors don't mind that half the products in your house are made by P&G, but none of them are branded that way.

tsschall said...

When I go shopping for toothpaste I look for Crest and know it will be there. I buy it at a pharmacy, local grocery, Wal-Mart.... If I want a Sleep Number bed I have the options of buying sight unseen online or by phone, or going to a Select Comfort store. As a Select Comfort Sleep Associate, I have had many folks wander into the store and and say something to the efect of "Oh, this is where Sleep Number beds are!" Yes, they seem genuinely suprised at the discovery. The company needs to do a better job of tying Sleep Number to Select Comfort, or rename the stores to match what we are to use when answering the phones, Thank you for calling the Sleep Number store."

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