1 Stock to Buy in May

This is what patiently aggressive investors live for -- a world-beating company whose stock falls 44% in less than three weeks while the market is flat (the Dow (INDEX: ^DJI  ) was down 0.2% in that time).

Did I mention that it's down on good news?

This isn't a history lesson. It just happened to this month's featured stock.

What happened
The trouble started when premium foam mattress maker Tempur-Pedic (NYSE: TPX  ) reported earnings on April 19. Its quarter was quite strong. It increased sales 18% over the 2011's first quarter and was operationally efficient enough to grow bottom-line earnings per share by 26%. That's strong growth on an absolute basis and was enough to beat analyst estimates.

So what gives?

Seasoned earnings watchers know that lowering guidance for the future can hose stock prices even if earnings are strong.

But that's not what Tempur-Pedic did. It kept the same full-year guidance it gave three months beforehand. The stock price fell because analysts were hoping for a guidance boost after a strong quarter.

Because management is being conservative and not micromanaging its guidance, the implied full-year growth is only 15% on the top line and 22% on the bottom line. Due to basic math, that's lower than its first-quarter performance.

Then on May 7, Tempur-Pedic confirmed that it was discounting one of its mattress lines 12% to 17% as a Memorial Day/Fourth of July promotion.

That combination of events scared the heck out of the market, resulting in a 44% stock price drop, because it seemed to confirm the big fear with Tempur-Pedic -- that increased competition from the likes of traditional innerspring mattress makers Sealy (NYSE: ZZ  ) , Simmons, and Serta would drive down Tempur-Pedic's enviable margins. Note that each of the "Big S's" now has a competing memory foam product. That's a much bigger threat than the generic knockoffs that have hounded Tempur-Pedic for years.

The reality
Yes, Tempur-Pedic faces stiffer competition via imitation now because of its success. But that's true of any successful consumer brand, from Coke to Tide detergent.

And management knew it was coming. As Dale Williams, Tempur-Pedic's CFO since 2003, puts it:

We've said for as long as I have been with this business, the long-term goal here, the long-term gain is not to necessarily maintain our share of specialty. We want specialty to become gain share in the market. And we expect to lose some share in specialty along that way. But if specialty is 20% of the market, and we are 70% of specialty, that's nice. But we'd much rather be 50% or 45% of specialty, and specialty be 50% of the market. That's a much better equation for us.

In other words, Tempur-Pedic doesn't care if it has a smaller percentage of the specialty (aka non-inner-spring) mattress business as long as that pie keeps growing. It's showing that in its actions -- the same actions that are scaring the market.

It boosted its advertising spending by 37% to increase its brand recognition (and thwart imitators). It's giving retail partners better incentives in order to increase its distribution footprint and store presence. It's kept up its research and development spending to better meet customer needs. And it's attacking its attackers.

How so? Some of that R&D spending over the last two years was used to develop its new lower-priced Simplicity line. Tempur-Pedic has traditionally played at price points of $2,000 and above. Now the Simplicity line allows it to play in the $1,000 to $2,000 range, which effectively doubles its addressable market. Watch out Sealy, Simmons, and Serta. You too, Select Comfort (Nasdaq: SCSS  ) .

Given the lower price points, the heavy spending on advertising and dealer incentives, and the continued R&D, you'd think margins would be getting crushed. You'd be wrong. The same guidance that the market thinks is weak calls for gross margins to increase 2% this year (they were a whopping 52.4% last year). And the net margins are robust enough that Tempur-Pedic now sells for just 12 times its earnings guidance for this year.

The bottom line 
Tempur-Pedic is one of my favorite companies, and I've personally owned its stock for a few years now. I've watched it disrupt the mattress industry with its high-end foam mattresses, and I expect it to continue to do so under its long-term-focused management. And I believe Tempur-Pedic's current share price weakness is a great buying opportunity. 

For another great real-time buying opportunity, read our free report: "The Stocks Only the Smartest Investors Are Buying." It details a sector of the market Warren Buffett invests in heavily but many individual investors avoid. Just click here to read more.

Anand Chokkavelu owns shares of Tempur-Pedic. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (29) | Recommend This Article (150)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 09, 2012, at 6:26 PM, daliya wrote:

    tempurpedic is toxic. Some people may catch on one day

  • Report this Comment On May 09, 2012, at 6:37 PM, mikecart1 wrote:

    1 stock to buy in May: Facebook. The End.

    At some point, you will be able to buy Facebook at one price and sell it for a higher price later - possibly in the same week or month. Isn't that what investing is all about? Who cares if the business model is flawed, if Mark has no clue of how to dress or run a publicly traded company, if Facebook itself is getting worse by the day, if you yourself find that you use Facebook less than you once did when it was still called TheFacebook, if you think the valuation is a joke, if you think anyone buying it for long-term is going to end up broke, if you think Facebook will be the turning point of the dot com v2.0 bubble burst, if you find 1000 other stocks better, if you think Facebook should have gone public at least 5 years ago...

    Money = Money

    :)

  • Report this Comment On May 09, 2012, at 6:46 PM, mocomber wrote:

    That combination of events scared the heck out of the market, resulting in a 44% stock price drop, because it seemed to confirm the big fear with Tempur-Pedic -- that increased

    Not 44%, 14% was the drop.

  • Report this Comment On May 09, 2012, at 6:47 PM, mocomber wrote:

    Sorry, 14 was the one day drop. 44 overall

  • Report this Comment On May 09, 2012, at 9:16 PM, NJ7 wrote:

    Dear Tempurpedic, f you start to lose your moat...

  • Report this Comment On May 09, 2012, at 10:28 PM, iheartweimers wrote:

    Let's see.....you've owned a boring stock that pays

    no dividend, and has just lost almost half of it's

    value, even though the industry is recession proof.

    (I assume people must sleep, and they now have the lower priced Simplicity line.) so this is a buy?

    I see that the CFO is leading the officer's suite in

    insider trading sales this Qtr, so I'll pass.

  • Report this Comment On May 09, 2012, at 10:50 PM, mountain8 wrote:

    The united states is losing it's moat.

  • Report this Comment On May 10, 2012, at 1:16 AM, etihwttam wrote:

    Can't speak to the stock, but really love the mattress I own. That said, my parents love their Select Comfort mattress just as much as I love Tempurpedic!

  • Report this Comment On May 11, 2012, at 11:10 AM, Luoyu wrote:

    A mattress is a mattress... I have a beatyrest I love. When I'm tired I appreciate a tired place. Any mattress will feel good. Go to a mattress store and try to figure out which is best. You will love them all.

  • Report this Comment On May 11, 2012, at 11:57 AM, tkell31 wrote:

    Economy is bad, people are out of work, TPX hardly seems like a must have. Maybe I'm wrong, keep pumping.

  • Report this Comment On May 11, 2012, at 12:16 PM, WineHouse wrote:

    Investing is NOT all about quick trades for quick bucks. Investing is not about "technical analysis" or timing-the-market. Quick trades for quick bucks, timing the market, and buying/selling based on "technical analysis" is gambling, not investing.

    Investing is what Warren Buffett does --

  • Report this Comment On May 11, 2012, at 1:22 PM, oberta wrote:

    Interesting and convincing story. However, I need more info before buying: - balance sheet quaterly or yearly- as well as an income statement. Ya, a 44% drop in shareprice is very attractive to buy.

  • Report this Comment On May 11, 2012, at 1:44 PM, pongun wrote:

    I checked out Tempurpedic -- while I love foam mattresses, I wasn't really wowed by the company. It's still trading at a 14 p/e, which is a little high (I'm a market bottom-feeder, personally), and its moat is shrinking a bit.

    The CFO is selling??? Okay, that made the decision REALLY easy. No, thanks. Maybe when it's a p/e of 5 or so and the CFO is on a buying spree...

    I'd rather be active when it comes to making the money. I like my stocks, real estate and loans to work FOR ME, instead of the other way around. Just personal preference.

  • Report this Comment On May 11, 2012, at 9:37 PM, Arnquist wrote:

    I love memory foam...have used a 4-inch topper for a few years to determine if it was worth buying the mattress. Resounding yes. Bought one last weekend at Nebraska Furniture Mart when I was in Omaha for the Berkshire Hathaway annual meeting. The only memory foam they carried was Simmons...and it was wonderful and while it was expensive, it was much less than the Tempurpedic would have been. So I see a growing market for memory foam, increased competition, pressure on margins...cause the volume at a place like Nebraska Furniture Mart is huge, and so even if Simmons margin is less per unit sold, they can make it up on volume...and that puts pressure on Tempurpedic. And it is a great mattress...with the newer technology--gel cool--that minimizes the problem of the foam retaining heat. Will I buy stock in Tempurpedic? Nope. The marketing cyce is beginning to move into the next phase, and that is larger market, but more competition and shrinking margins as a new product becomes a commodity rather than a sole offering by one company.

  • Report this Comment On May 11, 2012, at 9:50 PM, 619bell wrote:

    Talk about tempurpedic. How about wprt falling out of bed. Is it a buy, sell or hold?

  • Report this Comment On May 13, 2012, at 10:29 PM, MFMerlin wrote:

    Totally agree with the comments on shrinking margins. I recently purchased an 8" deep, queen size with a 10yr warranty for $350 and no shipping charge. These mattresses can be 'shrink wrapped' down to almost nothing and sent through the mail. You unwrap it, let it 'breathe' for a couple of days and it's ready-to-go. As I see it there is almost no 'moat' for any resellers of the actual foam product. The real money will probably be in latex rubber harvest and actual memory foam production - definitely a specailty process, but I'm not sure there's any good way to invest in those two pieces of the puzzle.

  • Report this Comment On May 14, 2012, at 9:23 PM, petersod wrote:

    Who buys stocks in May? Not the institutions, obviously, with a 6% drop in the Dow and S & P in less than 10 days (blame it on Greece, go ahead, it's easy) but I'll let Tempurpedic drop another 15% and then pick it up. Oh, it'll get there. As long as there's that motley crew of nations known as the Eurozone and a "sell first, ask questions later because it's May" mentality, why buy now?

  • Report this Comment On May 20, 2012, at 11:58 PM, dogintrouble wrote:

    Looks like the right "stock" on May 1 was SDS....

  • Report this Comment On June 06, 2012, at 11:24 AM, NC303 wrote:

    I guess buying in May means selling in June. Down ~47% to $23...

  • Report this Comment On June 06, 2012, at 11:56 AM, lupusstreet wrote:

    This analyst's recommendation seemed so powerful, I left skidmarks buying a position in this dog! I'd absolutely LOVE to hear his comments on Tempur-Pedic after today's performance.

  • Report this Comment On June 06, 2012, at 12:44 PM, islandstop wrote:

    Mr. Chokkavelu's big recommendation is now burning a big hole in my pocket. I would also LOVE to hear his comments.

  • Report this Comment On June 06, 2012, at 6:20 PM, Squirespeaks wrote:

    Thanks a lot. The article was too convincing.....I should have checked the institutional buying trend like Pongun did before I sunk $$ in this dog.

  • Report this Comment On June 06, 2012, at 10:28 PM, Kosar wrote:

    Defriending Chokkavelu, this was the worst trade of my life after today...no wonder the smart money has been dumping for weeks.

  • Report this Comment On June 07, 2012, at 9:55 AM, Schmax wrote:

    Defriending fool.com after finding that using the fool search for "1 Stock to Buy in May" no longer returns this article as a match.

  • Report this Comment On June 07, 2012, at 12:08 PM, LikeGlenLevit wrote:

    What is an easy way to tell whether an article published on fool.com is by a fool staff member versus a community member? I was led to this article by the fool watch weekly email where it was billed as the week's top story. I'm also curious as to whether the weekly top story is simply the one with the most hits or whether a fool staffer makes the pick.

  • Report this Comment On June 07, 2012, at 12:25 PM, SkepikI wrote:

    Well, lessons abound in this one. I am actually buying some in JUNE at 21.00/s turns out May was likely the WORST time to buy, but a good time to do some research. Maybe I will regret it and buy more at 10.00 in July! Only if my research is faulty. SO, do your homework fools.... do it often, do it well, and do it yourself! If you thought FB was a buy in May you were actually better off (I didn't)

    To those of you complaining that you moved fast on the strength of a single article by a "analyst", this could be the most valuable experience in your investing career!!!! THERE IS NEVER TIME TO DO IT RIGHT, BUT THERE IS ALWAYS TIME TO DO IT OVER...there's a thing to remember.

  • Report this Comment On June 07, 2012, at 12:43 PM, TMFBomb wrote:

    To understate, it's been a rough month for Tempur-Pedic since I wrote this article. Lowered guidance due to stronger competition has more than halved shares.

    I added to my long-held position in Tempur-Pedic after writing this article (when our trading rules allowed). I clearly misjudged the level of the competition in the near-term and perhaps the long-term, but I continue to hold my positions and am patiently following the story. I still like the company and its moves. One thing I'd advise against is making rash decisions on the stock after the recent fall. Whether it's buy, sell, or hold for you, don't let emotions cloud your investing analysis.

    -Anand

  • Report this Comment On June 07, 2012, at 8:01 PM, prozacvalium wrote:

    Anand, for recommending the worst stock in May,, time to look for another profession .

  • Report this Comment On June 10, 2012, at 1:13 PM, yaronfn wrote:

    As a new member of the site (stock adviser 30 day trial), this WAS indeed the only stock I bought in May. Little did I know that what appears to be a piece of thorough stock research was merely some fool's opinion, a wishful thinking.

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