On the surface, it looks as though GPS navigation giant and Motley Fool Stock Advisor pick Garmin (NASDAQ:GRMN) is firing on all cylinders. The first three quarters of 2006 appeared to be phenomenal. With 2007 estimated revenue growth around 30%, it certainly looks like the good times could last.

So why take the bear case? Because Garmin's beauty appears to only be skin-deep. First, its operating expenses are rising far faster than its revenues. Check out this table from its September 2006 quarterly report:

Sept. 2006 Quarter

Sept. 2005 Quarter

Net Sales



Cost of Goods Sold



Gross Profit



Research & Development



Selling, General, & Administrative



Total Operating Expenses



Operating Income



Other Income (Expense), Net



Income Before Income Taxes



Provision for Income Taxes



Net Income



The company's gross margins have shrunk, thanks largely to a shift in product mix. Yet of all the operating expenses, only R&D shrank as a percentage of sales. SG&A, in fact, was up 2%. The company attributes that SG&A hike to more aggressive advertising. That worries me, as it suggests that the company is struggling to keep up its sales increases. To top it off, were it not for substantial tax holidays and credits reducing its tax burden, its 10.7% net margin contractions would have been far worse.

Maturing market ahead
While the past has been spectacular for Garmin, I can't predict the same for its future. Unfortunately, higher advertising costs plus slower R&D growth equals about as sure a sign of a maturing market as exists anywhere. After all, R&D is the lifeblood of innovation. As a company grows, it needs more innovation, not less, to sustain sales growth at a decent rate on an ever-larger base. That's especially true for a company like Garmin that depends so heavily on non-recurring revenues from items that customers tend to buy and keep. Once the market is saturated, growth comes through upgrades. From a customer's perspective, if the next generation isn't sufficiently better than the last, why spend the money?

Similarly, if a company's products are flying off the shelves, why advertise ever more heavily? As a leader in its business, Garmin is already well known. It would seem to me that the heavy step-up in advertising is a tacit admission that the "easy" sales have already been made to those who need or really want a GPS system. That means the remaining market probably needs more convincing -- either to buy a system at all, or to buy a Garmin system over a lower-priced competitor's.

The unfortunate end game
Look no further than the automobile industry to see where that may wind up. According to an article in Advertising Age last year, that industry was the largest advertiser in the United States. Not only that, but if you rank the companies in that industry by their ad spending, it almost looks as though the less money they spent advertising, the more profitable they were. In fact, take out Toyota (NYSE:TM), and that's exactly what it does show.


2005 Advertiser Rank

2005 Profits

General Motors (NYSE:GM)


($10.6 billion)

Ford (NYSE:F)


$1.4 billion

DaimlerChrysler (NYSE:DCX)


$3.4 billion



$11.7 billion



$4.4 billion

Honda* (NYSE:HMC)


$5.1 billion

*Fiscal year ended March 31, 2006.

It could be a coincidence. Or it could be a sign that increasing advertising only goes so far when it comes to helping companies profitably build and maintain market share. Price, quality, and reputation leave a far more lasting impression than any 30-second TV spot ever will. Given the fact that both GPS systems and automobiles tend to be rare purchases for any individual, Garmin should take notice.

Shrinking margins. Higher reliance on advertising. Proportionally slower R&D growth. The combination of these trends does not add up to a tremendously strong future. Yet that combination is precisely what Garmin has delivered. As an investor, there's no penalty for sitting on the sidelines. When it comes to Garmin, that's where my cash will be.

There's more to this Duel! Go back and read the other three arguments, then vote for a winner.

At the time of publication, Fool contributor Chuck Saletta owned shares of General Motors. The Fool has a disclosure policy.