Until you're familiar with both sides of the story on a stock, you will never know it well enough to know when to hold it through volatility and when to fold.
The bulls' thesis is that 3D Systems Corporation (NYSE:DDD) is one of the leaders in the fast growing 3D printing market. The 3D market is set to grow tenfold over the next ten years; 3D Systems being a leader is likely to capture more than a fair share of this growth. It's already showing its credentials delivering 69% EPS growth last year and likely 100% next year and throwing off lots of free cash. They also point out that the stock has significant momentum and accumulation behind it.
The bears claim that if 3D Systems increases EPS to $14 in ten years (from the current $0.68) it still won't be a good investment. At a PE of 15, $14 equates to a $210 price. This is just a 13% annual return to the investor based on the current price. They also feel that $14 EPS would be a stretch given the rate at which they are issuing new shares to buy growth. They also point to the hidden risks that come from the opacity of its acquisition-led growth strategy, which makes it easy for management to obfuscate its true financial picture. They demand a lower price, given the dangers.
Overview of 3D Systems
3D Systems appears to be a high quality company.
It has a weak competitive advantage (customers using their printers are tied to their consumables) and a two to three year leadership position. 3D's acquisition strategy will also provide some protection from changing technology.
It has fair, but improving, earnings quality. Its margins are improving as higher margin consumables make up more of its revenue (vs. lower margin printers). It also generates a lot of free cash. (Vital quality statistics RoA: 10.6% RoE: 18.3% FCF/Earnings: $50m/$53m.)
It also has a solid balance sheet with low debt to equity and low debt to free cash flow. (Balance sheet statistics: Total Assets: $661m Share Equity: $416m Debt: $124m Cash: $184m Current Assets / Current Liabilities: $302m / $79m.)
On the negative side it continues to issue new shares, diluting its share base, in order to finance acquisitions, a strategy that it plans to continue. To an extent this dilutes the quality of its free cash flow.
We love 3D Systems' historic growth and every indication is that the growth in its primary market will support solid growth for many years to come. The growth projections and future for the 3D market are very compelling (+20% per annum over the next five to ten years).
And so far 3D Systems has stepped up to the base and taken a greater than fair share of the market growth. A caution is that half of its growth has been acquisition related, which makes it less valuable; it also makes it easier for management to manipulate earnings and cash flow. Though management claims 26% organic growth (we don't dispute this), some shorts have attacked their accounting. (Growth statistics: 3yr revenue growth: -18%, 42%, 44%. 3 year EPS growth: -ve comparison, -ve comparison, 69%. Last 3 quarters revenue growth: 63%, 53%, 57%. Last 3 quarters EPS growth: -14%, -38%, +71%. Last 3 quarters operating earnings growth: 43%, 75%, 800%.)
The poor EPS comparisons in the March and June quarters were due to tax rebates and higher taxes.
A glance at the charts indicates favourable timing for a purchase. The market is in a clear up trend. The stock is being accumulated by institutions with strong buying since October and the stock is being supported by its 15 day moving average.
The only reason to hesitate might be that the price has run up over the past few days and is relatively extended from its 15 day moving average. A pullback to this line is likely.
Unfortunately 3D Systems is selling at a PE of 90 and a forward PE of 40 based on consensus analyst earnings estimates. This leaves little in the area of margin of safety. Assuming 22% revenue growth over the next five years and continuing margin expansion to 60% gross margin, we still struggle to value this business using a DCF model at much above $26 (an implied PE of 38 vs. current earnings and 19 vs. 2013 earnings estimates.) Half the growth is acquisition related and financed through share issues. Even a rich 30 times next year's earnings would be $42 (vs. current price of $57).
This high valuation significantly increases the risk to a long term holder, whilst for the short term holder it will likely introduce a high level of volatility into the share price - making it very easy to buy at the wrong time and sell at the wrong time.
I like the growth, I like the chart. I think the quality is fair to good, but the valuation is through the stratosphere.
I think the bull thesis is right, investor sentiment is very positive and generally this will push up prices. The story is really compelling and is sure to shut down the rational brains of many investors. I can't help thinking that 3D Systems may well be the one who will be making the replicators for the Star Ship Enterprise. Why wouldn't you buy and hold that to the stratosphere and beyond?
I also think the bear thesis is right, it's not worth the current price, but that won't stop a great story from suppressing the logical brain and leaving the animal spirits free reign to drive the price higher in the short run. Some of the bears have gotten their timing wrong and are in there a tad too early and have to resort to shock and fear tactics to accelerate their argument. The bulls don't seem to be letting it interfere with the joy of the moment.
3D Systems is only for the experienced momentum speculator or if you have an edge in a better understanding of the 3D market. And only if you can set a stop and execute it, this is in the hands of momentum players and 3D hard cores. When it breaks it will likely lose half its market price quite quickly.