Shareholders of Tempur-Pedic International (NYSE:TPX) have had a decimating year with the share price falling nearly 45%. This decline represents a loss of $4 billion in shareholder value and many investors are questioning when the losses will end. Through this analysis, I present the case that Tempur-Pedic is a strong organization and that the current price levels may represent an excellent purchasing opportunity.
The first items we will examine in this report are return on assets and return on equity. These two metrics are very helpful in that they provide the analyst insight into the effectiveness of management to both generate a return on organizational assets, but also on shareholder equity.
The chart above shows the return on assets and return on equity for the previous three years. Let's examine the chart. The first growth figure we will examine is return on assets. As can be seen, return on assets has been increasing for the past three years, excluding the previous quarter. Additionally, the current return on assets for the organization is 24% - a very strong rate. Return on assets is basically the return a firm is able to generate on the assets that the firm uses to drive its revenues. A high return on assets demonstrates that the organization is intelligently using its assets to generate revenues for the firm. For the previous three years, Tempur-Pedic has steadily been increasing its return on assets which essentially means that it is more efficiently using its assets to earn profits.
The other item which has been graphed is return on equity. Return on equity is the return that management is able to generate based on the shareholder equity, which has been entrusted to the organization. With a return on equity currently near 300%, this means that management is earning a return nearly 3 times direct shareholder investment. This return was so astonishing that I decided to dig into the firm's financial statements to verify the chart. The organization is currently earning around $200 million based upon direct shareholder investment of only $30.7 million. This excellent performance demonstrates the effectiveness of Tempur-Pedic to deliver returns.
If the organization is generating such phenomenal returns, why is share price dropping? There are several answers to that question, but I believe that none of them are relevant. I believe that the current share price reflects an over-reactive speculative public to relatively minor organization news. Essentially, I view that the recent quarter of financial statements as an aberration in the face of the long-term fundamentals of Tempur-Pedic. For example, despite the fact that profit declined by 50% in the previous quarter, return on assets only declined by a few percentage points while return on equity actually increased.
Here's another way of looking at the situation. One of the ratios we just examined, return on assets, shows the firm's effectiveness at using assets to generate revenues. The growing ratio shows that no matter the quantity of assets, the firm is able to generate a return of roughly 20-25% each quarter on these assets. These historic returns provide significance to the below chart.
In the chart, it can clearly be seen that for the past three years, Tempur-Pedic has steadily increased assets. As assets have increased, the return generated on the assets has increased as well. What this means is that the more assets the firm is in possession of, the more revenue it has been able to generate on and above these assets. Essentially, if history is any guide, the return generated this previous quarter is an absolute anomaly - it is not in line with the long-term trend of this organization. This is why I believe that the recent decline in share price represents an excellent purchasing opportunity.
Tempur-Pedic has demonstrated for several years that it is more than capable of translating its assets into revenues. This demonstration of profit has been more pronounced by the fact that this return on assets that the firm generates has actually increased very consistently throughout time. Essentially, Tempur-Pedic is becoming better at what they do from a mathematical standpoint and they have a proven history of providing strong returns. With this in mind, I believe that investors who purchase Tempur-Pedic are purchasing an excellent company at a discounted price.
No matter the fundamental picture, we as investors should always factor in the technical picture. By examining the trends of the market, we can best time our investment and potentially save ourselves from large losses. The chart and comments below provide a technical synopsis of the forces at work within the market.
TPX is undoubtedly in a strong downtrend. The share price has collapsed over the previous two quarters and more pain could potentially be on the way. There are actionable levels that we should be aware of, however. The first is the 50-day moving average (green line). This is a widely watched indicator and it can provide support for our analysis. As long as price remains above the 50-day moving average, I will view this analysis as valid.
The next level to examine is the blue line on the chart. The blue line is the location at which we should participate in the rebound of TPX. This line is around $35 per share and it is the recent high of the stock. If price is able to travel above $35 per share, I believe that a purchase is warranted since the intermediate trend direction will have shifted to bullish at this level.
For any shareholders who purchase when the $35 threshold is overcome or for existing shareholders, I believe that being nimble is very important. Since the stock price has fallen and technically is still falling, we should be willing to exit our position if downward momentum resumes. This said, if the stock price falls below the 50-day moving average, I believe that all long positions should be exited and the investor should wait for a more favorable entry opportunity.