In the competitive spirit of college basketball's annual championship tournament, The Motley Fool brings you Stock Madness 2007! Our writers are making head-to-head arguments for their chosen stocks (but not necessarily investment recommendations -- this is, after all, a game), and you'll pick the winners with your article recommendations and Motley Fool CAPS ratings. Who will win the right to cut down the net? Let's tip things off and find out!
It's the price, stupid!
Price is everything when pursuing investment returns.
In Round 1, I made the case that the expectations built into Select Comfort's (NASDAQ:SCSS) current price are too low for its future performance. With Under Armour (NYSE:UA), we're not supposed to worry about its high price and the competition. I'm going to show you how expensive Under Armour is, and explain why competitors like Nike (NYSE:NKE), Adidas, Reebok, or even Russell Corporation, owned by Berkshire Hathaway (NYSE:BRK-B), are important.
Then you can vote Select Comfort into Round Three.
Round two
Let me get this right out of the way again: Under Armour is a great company with great products. But that doesn't make it a good investment today.
I want to evaluate Select Comfort and Under Armour using the enterprise-value-to-operating-income ratio, EV/EBIT. From there, I want to compare the EBIT growth levels for both companies. That will give us an idea of the expectations built into the value of the company.
The showdown!
There's 10 seconds left on the clock, and Select Comfort has to inbound the ball, get it up the court, and hit the game-winning shot. Is it up to the challenge? You bet it is.
In 2007, Under Armour's management expects EBIT to grow about 33%. As of March 20, its enterprise value was $2.278 billion, given trailing and forward EV/EBIT ratios of 39 and 30, respectively.
At Select Comfort, management expects EBIT to grow 20%. Its trailing and forward ratios are 10.7 and 8.9, respectively.
So far, Select Comfort has broken through the full-court trap. On a relative basis, it's a significantly better opportunity -- growth on sale. It's going to be tough for Under Armour to keep growing at very high rates in order to maintain its multiple.
There are still five seconds left on the clock.
Competition is a ...
Remember those competitors up above? They aren't going away.
When I go into Dick's Sporting Goods (NYSE:DKS) or Foot Locker (NYSE:FL), I will always have a choice. And the retailers will work the competitors against each other to lower prices and battle for premium spaces.
Sorry, but competition is important, and it will cause future returns to shrink and future growth to slow. When that happens, Under Armour's multiple will decline. So again, the key is not to pay too high a price today for future expectations.
On to Round 3
The guard found an open man on the baseline! There's three seconds left. He catches the ball and takes it to the hole (two seconds). He rises (one second) and shakes the house with a monster dunk! It's over! You get a better deal with Select Comfort!
Select Comfort is a great business selling at a cheap price, whereas Under Armour is a great business selling at a high price. If you agree with my thesis, then you have to follow this link to rate Select Comfort an "outperform" in Motley Fool CAPS and grab these easy points. If not, vote it "underperform." Later this week, we'll tally your votes to determine which stocks will advance one step closer to the title.
Read our opposing entry on Under Armour, and see all our articles in the tournament.
Think you could pitch your favorite stock -- or ditch your least favorite one -- in less than 27 seconds? That's what we're doing over at Motley Fool CAPS. Check out our new stock videos.
Select Comfort is a Hidden Gems recommendation. Berkshire Hathaway is an Inside Value pick.
Retail editor David Meier thinks he gained an investing advantage at Wake Forest. He owns shares of Nike, but does not own shares in any of the other companies mentioned. He is currently ranked 428 out of 24,208 investors in The Motley Fool's CAPS rating service. You can view his TMF profile here. The Fool takes its disclosure policy very seriously.
