Is Select Comfort's Stock Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Select Comfort (NASDAQ: SCSS  ) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Select Comfort's story, and we'll be grading the quality of that story in several ways:

  • Growth: Are profits, margins, and free cash flow all increasing?
  • Valuation: Is share price growing in line with earnings per share?
  • Opportunities: Is return on equity increasing while debt to equity declines?
  • Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at Select Comfort's key statistics:

SCSS Total Return Price Chart

Source: SCSS Total Return Price data by YCharts.

Passing Criteria

3-Year* Change 

Grade

Revenue growth > 30%

71.8%

Pass

Improving profit margin

(78.1%)

Fail

Free cash flow growth > Net income growth

(19.2%) vs. 119.7%

Fail

Improving EPS

77.9%

Pass

Stock growth (+ 15%) < EPS growth

183.7% vs. 77.9%

Fail

Source: YCharts. * Period begins at end of Q4 2009.

SCSS Return on Equity Chart

Source: SCSS Return on Equity data by YCharts.

Passing Criteria

3-Year* Change

Grade

Improving return on equity

(41.8%) **

Fail

Declining debt to equity

(100%)

Pass

Source: YCharts. * Period begins at end of Q4 2009.
** Begins at Q4 2010 due to abnormally high starting value in 2009.

How we got here and where we're going
Despite significant growth on some metrics, Select Comfort's had a hard time justifying its share price of late -- which may explain why shares have fallen so far in the past few months. At three of seven passing grades, Select Comfort's performance definitely leaves room for improvement. For curious investors, the question is: will that improvement happen in 2013? If not now, when?

Select Comfort's been tossing and turning uncomfortably all year. Its latest agony, which arrived last month, warned of a short-term sales weakness that resulted in big profit target cuts on Wall Street. Despite the worry, Select Comfort's forward P/E is an even 10  as of this writing, and could easily slip into single digits on one underwhelming day. Keep in mind, also, that the average $1.85 price target cited last month is still a 35% increase over 2012's result.

That makes Select Comfort, surprisingly, the best bargain by far in the shrinking mattress segment. An acquisition last year left only Tempur-Pedic (NYSE: TPX  ) and Mattress Firm remaining to contend with Select Comfort, and at present both have P/E's more than twice as high as that of the maker of Sleep Number beds. This is a bit surprising, as the last time I examined Tempur-Pedic, it was the best value, and part of that rationale was that its growth rates were reportedly lower than Select Comfort's. How the tables have turned.

My fellow Fool Michael B. Lewis notes that the sector is particularly susceptible to any perceived demand slowdown, and that it's likely to be a bumpy ride for investors over the next few months. Everyone needs a place to lay their head, but Select Comfort and Tempur-Pedic are both premium brands in a sector that hasn't yet managed to convince the world that it's really worth spending more on something in which you spend roughly a third of your life. Housing growth tends to translate into a bedding boom, but Select Comfort has a massive market of coiled-spring mattress owners waiting to be convinced to trade up. That argument is one that shareholders hope the company can make sooner rather than later.

Putting the pieces together
Today, Select Comfort has some of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.

The Motley Fool's chief investment officer has selected his No. 1 stock for the next year. Find out which stock it is in the brand-new free report: "The Motley Fool's Top Stock for 2013." Just click here to access the report and find out the name of this under-the-radar company.

Keep track of Select Comfort by adding it to your free stock Watchlist.


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