There are often two phases in the trajectory of a hot stock. The first phase is when growth prospects are pushing shares higher.
The second phase comes when momentum investors take over and keep pushing shares higher still, even if the financial statements are flashing warning signs. That second phase can end quite badly when momentum investors head for the exits.
That encapsulates the rapid rise and sudden plunge for 3D Systems (NYSE: DDD), which after a meteoric rise in recent years, has stumbled badly in 2014 and is now below its 100-day moving average.
Investors should not have been caught off-guard. As I noted back in September, the company's repeated capital raises in prior years were frittered away on questionable acquisitions, and 3D Systems' accounts receivables and cash-flow metrics were also flashing red.
Shares moved much higher after I raised those concerns -- as momentum investors took hold of the stock -- and now they are almost back down to levels seen back in September. At this point, investors are wondering if the pullback means it's time to buy, or if this stock's downward slide is set to continue.
To answer that, a closer look at the numbers is needed. And 3D Systems won't actually delineate all of its financial metrics until fourth-quarter results are released Feb. 24. But a recent pre-announcement of a few key numbers should give investors pause.
The company generated roughly $515 million in sales in 2013, representing 45% annual growth. Organic growth was likely in the 25% to 30% range, which is impressive, but not as robust as momentum investors would like to see.
|My greatest concern for this stock -- and the broader 3-D printing industry -- is a looming set of patent expirations. According to one source, 11 key industry patents will expire this year alone.|
Of greater concern, the company likely earned around $0.85 a share, while analysts had been previously expecting earnings per share (EPS) of nearly $1 a share. Fourth-quarter profits will likely be around $0.20 a share (down from $0.26 a share in the fourth quarter of 2012), which is roughly a dime lower than analysts had been expecting.
The company concedes that profit margins have come under pressure, which you typically only see when a high-growth industry matures and a fight for market share leads to price wars.
The key issue with tepid profit margins is the corresponding impact on price-to-sales ratios. Companies with very strong margins, such as software developers, can trade up to eight or even 10 times projected sales. Companies, especially those that sell into industrial markets, tend to have lower profit margins, and often trade for two to three times' sales. Even after its recent plunge, shares of 3D Systems trade for roughly 10 times projected 2014 sales.
My greatest concern for this stock -- and the broader 3-D printing industry -- is a looming set of patent expirations. According to one source, 11 key industry patents will expire this year alone. Not only will that likely lead to greater competition and pricing pressures, but it also diminishes the desire for potential suitors to look to acquire a leading player.
3D Systems in particular has pursued a growth-through-acquisitions strategy that appears designed to pump up its revenue base to appeal to potential suitors. Yet as I noted back in September, many of those acquisitions appear to have been a waste of the company's money.
The stage is now set for the full release of annual financial statements two weeks from now. Investors will be able to see the impact of all of those acquisitions, along with the industry trends regarding pricing and margins. In recent years, margins have strengthened, but last week's pre-announcement implies that the trends stalled out in 2013.
The company's outlook for 2014 will also get a lot of scrutiny. For the past few years, investors have been primarily fixated on top-line growth, fueling a robust price-to-sales multiple. They ignored the fact that shares typically traded for more than 100 times projected profits. Profit valuations are only now beginning to enter the discussion.
Another metric to note: accounts receivables DSOs (days sales outstanding). Back in June, DSOs spiked to 88, but pulled back a bit in September. Any number above 80 is too high, and management needs to show improved receivables collections to beat back concerns that 3D Systems is stuffing the channel to meet sales targets.
Risks to Consider: The lack of complete data in last week's pre-announcement means that more shoes may drop when full results are released in two weeks. The odds of the full numbers appearing more promising than the partial set of data is remote, and there's no reason to rush to buy shares in the interim.
Action to Take --> Based on near-term results, this remains a very expensive stock. To justify the current share price, let alone any rebound from here, management needs to clearly spell out how long-term organic growth can be sustained -- and how profit margins won't be sacrificed in the process. With looming patent expirations, rising competition and margin pressures, and diminished hopes for a buyout, this stock will no longer get a free pass from investors. And more downside lies ahead, perhaps to levels below $50, if analysts are forced to slash their 2014 estimates even further in coming months.