4 Reminders from Tempur-Pedic
Keith is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
How the mighty can fall. In April, Tempur-Pedic (NYSE: TPX) was up over 60% for the year. The stock attracted quite a bit of attention from investors. Investor's Business Daily listed Tempur-Pedic in its top 50 stocks. That was then.
Tempur-Pedic is currently trading over 60% less than its starting point in January. If you’re keeping count, that is a swing of more than 120% in two months. The decline began on April 20 after the mattress company missed revenue expectations. On June 5, Tempur-Pedic announced that it was cutting earnings guidance for the year from $3.80 per share to $2.70 per share. The stock immediately plummeted by nearly 40% then continued to slide more throughout the day. It is now trading at less than half its price from earlier this week.
I didn’t own Tempur-Pedic shares during these precipitous drops, but I have owned the stock in the past. This rapid fall has reminded me of a few important lessons that most investors already know. But it doesn’t hurt to be reminded from time to time. Here are four reminders to take to heart from the Tempur-Pedic saga.
1. Don’t Put All Your Eggs in One Basket
Imagine if you had everything invested in Tempur-Pedic earlier this week. You would have woken up on Wednesday with a lot less money in your account.
Tempur-Pedic is just one company that illustrates the wisdom of the old adage that you shouldn’t put all your eggs in one basket. Green Mountain Coffee (NASDAQ: GMCR) is another recent object lesson in this regard. GMCR was up over 50% year-to-date by February. Now the stock is nearly 50% less than where it was at the start of 2012. Like Tempur-Pedic, Green Mountain dropped around 40% overnight on negative news.
I do partially agree with the statement attributed to both Andrew Carnegie and Mark Twain: “Put all your eggs in one basket and watch that basket.” Investors should definitely watch their baskets. However, the market itself continually teaches the importance of diversification.
2. Past Performance Doesn’t Guarantee Future Success
We typically skip past these familiar words included on every piece of literature and every advertisement from investment companies. But they are critical to remember in investing.
In Tempur-Pedic’s case, their past performance was stellar. Return on equity was an astronomical 183%. Revenue in 2011 was up 28% versus 2010. Net income was up nearly 40%. Cash flow was increasing greatly. But like a college professor of mine used to say, “All of that and fifty cents will buy you a cup of coffee.” (I went to college over 20 years ago, by the way.)
Research In Motion (NASDAQ: BBRY) is another example for this point. It wasn’t long ago that nearly every business traveler in airports had Blackberry phones and the stock price reflected it. Some investors assumed that Research In Motion would keep on succeeding because they had in the past. Following that assumption blindly would have led them to a loss of 85% since early 2011.
Markets are forward looking. While investors must use past performance in making decisions, the market bases prices on future expectations. Even the smartest, most successful investor alive can’t guarantee what the future holds.
3. Don’t Try to Catch a Falling Knife
Some people make the mistake of thinking that a stock that has been successful in the past will automatically bounce back after it falls. Au contraire, mon frere.
Let’s say you watched Tempur-Pedic fall in April by over 10%. The company had a great track record. The stock was down. So you jump in and buy it, thinking that surely it could do nothing but go up from there. Except it went down more. A lot more.
Tempur-Pedic has plenty of company. Netflix (NASDAQ: NFLX) is a good case study. After a 90% gain in just over a month earlier this year, the stock drifted downward by 30%. Time to buy? No. The knife kept falling and falling. Netflix is now 7% below its 2012 starting point and less than half its year-to-date high.
4. Major Market Reactions Can Present Opportunities
We should also be reminded that sometimes big market reactions to bad news presents great opportunities. Benjamin Graham used the analogy of “Mr. Market”, the man who is often either overly ecstatic or overly depressed. When he is overly ecstatic, you should sell to him and get a great price. When he is overly depressed, buy from him at bargain prices.
Mr. Market’s depression over Tempur-Pedic is warranted, but he might be too depressed. The company has considerable room to grow both in North America and internationally. A rebound in the housing market would be a major catalyst for the stock. After its catastrophic decline, Tempur-Pedic now has a forward PEG ratio of 0.41 assuming annual growth of 16% versus an average of over 25% annual growth during the past five years.
Recall how British Petroleum (NYSE: BP) shares were hammered in the wake of the Gulf oil spill debacle in 2010. While the stock deservedly tanked, the markets overreacted. Share prices for BP fell more than the financial impact for the company warranted. Investors who researched the situation were able to profit over Mr. Market’s overly acute depression.
Tempur-Pedic and several of its competitors make mattresses that “remember” the contour of your body and claim to help you sleep more comfortably. While I can’t attest to those claims personally, there is an investing parallel.
If we as investors remember how the market has performed in the past, we can invest more effectively. Stocks get hit hard sometimes. Diversify. Business changes turn great performers into poor performers. Continually reevaluate. Stocks that fall sometimes fall even more. Tread lightly.
And sometimes - often, even - stocks get beaten down too much and present excellent buying opportunities. Recognize these situations and buy. I’m glad I didn’t own Tempur-Pedic this time around. But thanks for the reminders. I can sleep better remembering them.
Keith Speights (www.keithspeights.com) has no positions in the stocks mentioned above. The Motley Fool owns shares of Netflix and Tempur-Pedic International. Motley Fool newsletter services recommend Green Mountain Coffee Roasters and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.