Dueling Fools: Select Comfort Bear

When was the last time you bought a bed? If you have bought one recently, when was the time before that? If you're at all like most people, it's pretty easy to go well over a decade without buying a new bed. Even if you're thinking about it, do you really need one, or could your current bed do for awhile longer?

Unfortunately for investors, the customer decision factors that go into buying a bed are much like the ones that go into buying a car. They're both expensive, rare purchases that can usually be postponed if higher priorities come around. That makes both industries heavily sensitive to the economic cycle and consumers' perceptions of their future financial well-being. As the current financial difficulties facing automobile titans Ford (NYSE: F  ) , DaimlerChrysler (NYSE: DCX  ) , and General Motors (NYSE: GM  ) clearly show, such cyclicality often leads to erratic long-term performance.

As its long-term stock chart shows, Select Comfort (Nasdaq: SCSS  ) isn't immune to that reality. There's nothing wrong with investing in cyclical companies, but generally speaking, the time to buy one is when things look worst, and the time to sell one is when things look best. Right now, things look exceptionally rosy for Select Comfort, and that worries me. Analysts estimate that it will grow some 26.8% in the next year, during the same period that the overall industry is expected to shrink some 3.3%.

To paraphrase Warren Buffett: "When a company with a reputation for brilliance tackles an industry with a reputation for bad economics, the reputation of the industry remains intact." Try as it might, no company can outgrow its industry forever; yet Select Comfort is priced as if the market expects it to do just that.

Company

Market Cap

TTM Reve-nues*

Forward P/E

5-Year Expected Growth Rate

Select Comfort

$1.23 Billion

$765.09 Million

18.6

23%

Tempur-Pedic (NYSE: TPX  )

$1.48 Billion

$869.29 Million

12.4

14.6%

Sealy (NYSE: ZZ  )

$1.26 Billion

$1.53 Billion

11.9

15%

*TTM = Trailing-12-Months

The market is charging far more for Select Comfort's expected future earnings than it is for the company's larger public competitors, illustrating its expectations of faster growth. The more anticipated growth that's priced into a company's stock, the farther it has to fall the next time it stumbles.

Company vs. its stock
Don't get me wrong, I very much admire Select Comfort's innovative, adjustable air bed and the way it allows people to regularly choose and change their mattress firmness. As a potential customer, I'm absolutely convinced that I would be able to sleep well at night on one of its beds. As a potential investor, however, I'm not quite sure I'd sleep at night if I bought its stock at current levels.

My Foolish colleagues at Motley Fool Hidden Gems first picked this diamond in the rough a bit more than two years ago, when it was much smaller and far less well known. At the time, it was a disruptive upstart with a great innovation and logistics execution in a sleepy industry. As Select Comfort has grown and matured, its shares have easily outpaced the S&P 500. Yet now that it has come of age, is established as a serious competitor, and faces the very real constraints of its overall market's size, it's time to ask whether that original analysis still holds.

A company can be the absolute best at what it does and be a paragon of corporate ethics, yet its long-term performance will still be constrained by the market in which it operates. The larger a part of its industry it is, the bigger that constraining effect will be. With Select Comfort's stock now trading in line with the largest public firm in the industry, future share price growth depends on operational growth that may not materialize. New shareholders simply cannot count on the success of the past to propel their holding forward in the future. Select Comfort is a great company that's certainly worth watching, but I'd wait for its stock to be a more compelling value before buying shares.

Think you're done with the Duel? You're not! Go back and read the other three arguments, and then vote for a winner and share your opinion atMotley Fool CAPS.

At the time of publication, Fool contributor Chuck Saletta owned shares of General Motors. The Fool's disclosure policy helps us all sleep better at night.


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