One US share to buy in May

This is what patiently aggressive investors live for — a world-beating company whose stock falls 44% in less than three weeks

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This is what patiently aggressive investors live for — a world-beating company whose stock falls 44% in less than three weeks while the market is flat (the Dow (INDEX: ^DJI) was down 0.2% in that time, the All Ordinaries (Index: ^AORD) (ASX: XAO) had lost 1.5%).

Did I mention that it's down on good news?

This isn't a history lesson. It just happened to this month's featured stock.

What happened
The trouble started when premium foam mattress maker Tempur-Pedic (NYSE: TPX) reported earnings on April 19. Its quarter was quite strong. It increased sales 18% over the 2011's first quarter and was operationally efficient enough to grow bottom-line earnings per share by 26%. That's strong growth on an absolute basis and was enough to beat analyst estimates.

So what gives?

Seasoned earnings watchers know that lowering guidance for the future can hose stock prices even if earnings are strong.

But that's not what Tempur-Pedic did. It kept the same full-year guidance it gave three months beforehand. The stock price fell because analysts were hoping for a guidance boost after a strong quarter.

Because management is being conservative and not micromanaging its guidance, the implied full-year growth is only 15% on the top line and 22% on the bottom line. Due to basic math, that's lower than its first-quarter performance.

Then on May 7, Tempur-Pedic confirmed that it was discounting one of its mattress lines 12% to 17% as a Memorial Day/Fourth of July promotion.

That combination of events scared the heck out of the market, resulting in a 44% stock price drop, because it seemed to confirm the big fear with Tempur-Pedic — that increased competition from the likes of traditional innerspring mattress makers Sealy (NYSE: ZZ) , Simmons, and Serta would drive down Tempur-Pedic's enviable margins. Note that each of the "Big S's" now has a competing memory foam product. That's a much bigger threat than the generic knockoffs that have hounded Tempur-Pedic for years.

The reality
Yes, Tempur-Pedic faces stiffer competition via imitation now because of its success. But that's true of any successful consumer brand, from Coke to Tide detergent.

And management knew it was coming. As Dale Williams, Tempur-Pedic's CFO since 2003, puts it:

We've said for as long as I have been with this business, the long-term goal here, the long-term gain is not to necessarily maintain our share of specialty. We want specialty to become gain share in the market. And we expect to lose some share in specialty along that way. But if specialty is 20% of the market, and we are 70% of specialty, that's nice. But we'd much rather be 50% or 45% of specialty, and specialty be 50% of the market. That's a much better equation for us.

In other words, Tempur-Pedic doesn't care if it has a smaller percentage of the specialty (aka non-inner-spring) mattress business as long as that pie keeps growing. It's showing that in its actions — the same actions that are scaring the market.

It boosted its advertising spending by 37% to increase its brand recognition (and thwart imitators). It's giving retail partners — possibly including Harvey Norman (ASX: HVN) here in Australia — better incentives in order to increase its distribution footprint and store presence. It's kept up its research and development spending to better meet customer needs. And it's attacking its attackers.

How so? Some of that R&D spending over the last two years was used to develop its new lower-priced Simplicity line. Tempur-Pedic has traditionally played at price points of $US2,000 and above. Now the Simplicity line allows it to play in the $US1,000 to $US2,000 range, which effectively doubles its addressable market.

Given the lower price points, the heavy spending on advertising and dealer incentives, and the continued R&D, you'd think margins would be getting crushed. You'd be wrong. The same guidance that the market thinks is weak calls for gross margins to increase 2% this year (they were a whopping 52.4% last year). And the net margins are robust enough that Tempur-Pedic now sells for just 12 times its earnings guidance for this year.

The bottom line
Tempur-Pedic is one of my favorite companies and I've personally owned its stock for a few years now. I've watched it disrupt the mattress industry with its high-end foam mattresses and I expect it to continue to do so under its long-term-focused management. And I believe Tempur-Pedic's current share price weakness is a great buying opportunity.

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 The Motley Fool's purpose is to help the world invest, better. Take Stock is The Motley Fool's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it's still available. This article was originally written by  Anand Chokkavelu and published on Anand owns shares in Tempur-Medic. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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