Cisco Systems (NASDAQ:CSCO) is one of the strongest technology companies in the world. It continues to dominate its primary business of computer networking. Thanks to smart acquisitions like Scientific Atlanta, it's also gaining a foothold into related industries like television entertainment delivery.
In spite of the fact that Cisco is an excellent company, investors' returns have depended entirely on how much they paid for their stock. Its recent price of around $26 is significantly below its bubble peak above $80 but well above its post-bubble collapse of around $8. Whether you're enjoying a triple or a loss of two-thirds of your money depends entirely on how much you were willing to pay. The key lesson: value matters.
Not just a bubble problem
Of course, the Nasdaq bubble was a relatively rare event. You might want to believe that under ordinary circumstances, the market is far more rational. Yet even as recently as last October, the market placed an outrageous premium on an otherwise great company, bedding pioneer Select Comfort (NASDAQ:SCSS). At that time, I made the bear case against the stock. It was unfortunate, because the deeper I dug into the company, the more I liked it. I looked at it and saw:
- No long-term debt
- Enough short-term assets to wipe out total liabilities
- Decent long-run prospects
- Steady share count for the past few years
All in all, I saw a conservatively capitalized, innovative company in an otherwise boring industry. It was exactly the sort of sleeper stock that I love owning. As a bear, there was only one problem I could see: valuation. Select Comfort traded in the same market-cap ballpark as its larger and more profitable competition, notably Sealy (NYSE:ZZ) and Tempur-Pedic (NYSE:TPX).
In the end, the only bear point I could muster was that Select Comfort looked, felt, and traded like a rapid growth company in what is clearly a stable or even cyclical industry. The voting for that duel showed just how weak an argument that seemed at the time. I lost in the balloting by about a 3-to-1 margin.
Fast-forward
It wasn't too much later, however, that Select Comfort's rapid growth story began to unravel. First, there was the Oct. 24 earnings announcement that "sales did not meet our expectations." Then, this followed suit, on Nov. 30: "This quarter's sales have been disappointing, as we've noted a closer correlation in our business with housing industry trends." In less than two months, the former growth darling of the bedding world revealed itself to be constrained by its market, after all. Predictably, its stock sank on the one-two punch of that news -- ultimately dropping more 30% from the time I made my case against its valuation.
So I did what any hungry, self respecting bear would do. I bought shares for myself. After all, my only concern had been its valuation. At $24.54, it looked overpriced. When the first round of bad news knocked it down around $20, it started looking reasonable. And when it dropped down to $16.83 this January, the market made me an offer I couldn't refuse.
Invest to make money
In truth, nothing had really changed about Select Comfort -- except the market's perception. None of us can control the market, but we can control where, when, and how we choose to invest. To value investors like those of us at Motley Fool Inside Value, paying the right price is at least as important as buying the right companies. That's why value investing has been such a powerful, market-trouncing strategy for generations. In the aggregate and over long stretches of time, the market does a tremendous job at valuing companies appropriately. On a day-to-day basis, however, a company's market price is little more than the opinion of the people involved in its most recent transactions.
Fortunately for we value hounds, this sort of thing happens all the time. Within the past year, for instance, you could have paid anywhere between $15.93 and $42.70 for a single share of Advanced Micro Devices (NYSE:AMD). At its peak, AMD looked like it had the upper hand over its archrival Intel (NASDAQ:INTC). Yet even as AMD was topping out, the market should have been well aware of Intel's Core Duo chips and their potential to vault Intel back into the driver's seat. AMD is more or less the same company it was back then, with the same competition, the same risks, and the same strategy. As with Select Comfort, the only real difference was the market's perception. Yet if you had bought AMD near the high, you could very well have lost more than half your money in less than a year.
It ain't rocket science
Amazingly enough, in spite of the tremendous profit potential, value investing is about as straightforward a strategy as there is. To be successful, you just need to answer one question: "What's it worth?" The less you pay when compared to that true worth, the more of a good company you'll get for your investing dollar, and the more powerful your returns will be.
"What's it worth?" is so key to the value strategy, in fact, that at Inside Value, we have an online valuation calculator, available here for our subscribers. (If you're not yet a member, you can start your 30-day free trial here.) Simply plug in your projections of what the company will earn for the future, and it will tell you what the company is worth today. With that information, you can then figure out what's the right price to pay for the right company to own. If, like me, you'd rather buy Select Comfort below $17 than above $24, then you had better make "What's it worth?" a key part of your investing strategy. Join us at Inside Value to get started asking that exact question.
At the time of publication, Fool contributor Chuck Saletta owned shares of Select Comfort and Intel. Select Comfort is a Motley Fool Hidden Gems selection, and Intel is an Inside Value pick. The Fool has a disclosure policy.
