Investors Can Sleep Well With Select Comfort

Select Comfort (SNBR -7.05%) has declined over the past year, and now trades at an attractive valuation given its financial position.

Select Comfort data by YCharts

Select Comfort's main publicly traded rival is Tempur Sealy International (TPX 0.42%), which is significantly more expensive than Select Comfort based on several valuation metrics. However, Tempur Sealy is levered to a substantial degree and does not have proprietary control over how its products are sold in stores, unlike those controlled by Mattress Firm Holding (NASDAQ: MFRM). Select Comfort, on the other hand, maintains its own stores, similar to Apple, and has control over how its mattresses are delivered and marketed to consumers.

Data Source: Morningstar & Yahoo! Finance

Select Comfort is a bargain compared to Tempur Sealy and Mattress Firm
Based on earnings over the trailing-12 months, Select Comfort offers the best value compared to Tempur Sealy and Mattress Firm. Tempur Sealy's P/E is almost twice that of Select Comfort, and Mattress Firm's P/E is about one and a half times that of Select Comfort. The disparities are not as wide on a forward earnings basis, but Select Comfort sill offers the best value out of the three; it has a forward P/E of 14 compared to Tempur Sealy's and Mattress Firm's 16 and 22, respectively.

On a forward basis, Select Comfort is also the consensus bargain with a five-year PEG ratio of 0.7. A stock with a PEG of less than 1 is considered undervalued, and Select Comfort certainly fits that bill. Still, Mattress Firm's PEG of 1 gives it a fair valuation, and Tempur Sealy's PEG of 1.3 is not an extreme overvaluation on this basis.

Tempur Sealy does diverge from the other two companies on a cash flow basis, however. Tempur Sealy's P/CF multiple of 37 is quite expensive compared to the other two, coming in at almost three times the P/CF of Select Comfort and about two and a half times that of Mattress Firm.

No debt is a good thing to have
Select Comfort carries zero debt on its balance sheet and still manages to get great returns on equity. In the last three years starting with 2011, Select Comfort has generated returns on equity of approximately 64.6%, 48.3%, and 28.7%, respectively. In the last 12 months, the company generated an ROE of 24.2%. The declining ROE numbers are understandable as the company matures and gets diminishing returns on larger sums of capital.

Tempur Sealy has also generated significant returns on equity over the last three years but has done so by employing a large amount of debt. Its returns on equity over the last three years starting in 2011 have been 280%, 402.3%, and 111.6%. The corresponding returns on capital are much smaller, however, at 39.6%, 14.3%, and about 9.7%, respectively. In the last 12 months, Tempur Sealy has generated an ROE of 104.5% and a corresponding ROC of 7.9%. Tempur Sealy is generating large returns on equity but its returns on capital are falling, an insidious trend for a company with debt. Therefore, an investment in Tempur Sealy is much more risky than one in Select Comfort.

Mattress Firm has also posted respectable returns on equity and capital over the last three years; but it falls short of Select Comfort with smaller returns and by employing debt. In the last three years starting in 2011, Mattress Firm has generated returns on equity of 32.9%, 16.2%, and about 17.8%. The corresponding returns on capital have been 3.6%, approximately 7%, and 9.9%. So, returns on equity have fallen, but the returns on capital have risen; that's a good trend and the opposite of what Tempur Sealy is experiencing.

Foolish takeaway
Select Comfort is the clear value play based on the valuation multiples explored in this article. Moreover, it is a company with a solid financial position, especially compared to its competitor Tempur Sealy, and has generated solid returns on equity without any debt. With control over its operations and an envious financial position, Select Comfort can implement and see through its strategies on vertical as well as horizontal bases. The company has the ability to forge its own destiny and is trading at an attractive valuation with past success.