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ExOne systems (XONE) was down more than 15% after hours yesterday (about 8% down today) after the company announced Q2 earnings.

  • Revenue increased by $4.5 million, or 97%, over prior-year second quarter
  • Gross margin improved to 45%, from 33% in the second quarter of the prior year

  • Second quarter net loss attributable to ExOne reduced to $1.1 million from last year's second quarter $3.6 million net loss

  • Company confirms 2013 guidance at lower end of revenue range and higher end of gross margin range

On the face of it these results look very good and they are. However, they were not exactly what the market was looking for, and the stock sold off. The question is, what was the market looking for?

ExOne reported an adjusted EPS loss of $0.08 per share, with expectations of a $0.06 per share loss. The company's Q2 revenue came in at $9.2 million, against the average analyst estimate of $9.33 million.

So the stock sold off after hours because it lost an additional $0.02 per share and sales came in at $0.13 million less than expected? If you ask me, there isn't anything ExOne could have come up with to satisfy or surprise the market. The reason for this is that this stock is one big bubble.

As of yesterday before the sell-off, ExOne had a market cap of about $1 billion. Put it another way, it was trading at 29 times trailing sales. Let me repeat that, this stock was trading at a Price/Sales ratio of 29. There is no formula of any kind that I can come up with to justify such a high valuation for any company, even assuming the company was making money, which it is not.

In addition, the one year price target as per analyst consensus is $57 (I would really like to know how analysts come up even with this number), but the market for some odd reason bid this stock all the way to $75.

But it's not just ExOne in the 3D space that's a bubble, the other high flying 3D stocks are also bubbles. Irrespective of growth or profits, very few stocks in the universe could probably justify a valuation of anything above 5-6 sales. Yet both 3D superstar stocks bellow are trading for double that.

P/E

Forward P/E

P/B

Price/Sales

Stratasys (SSYS)

N/A

40

2.5

12

3D Systems (DDD)

113

38

6

12

I am not telling you not to buy Stratasys, 3D Systems or ExOne based on the Price/Sales metric alone, but I am telling you that any stock with such a high valuation, is prone to a massive correction at some point in time in the future. Let me give you some examples.

SSYS Chart
(Click to enlarge)

SSYS data by YCharts

DDD Chart
(Click to enlarge)

DDD data by YCharts

As you can see from the above charts, both 3D Systems and Stratasys have been increasing in value relative to their revenue. But in my book, there is a limit to how long this can last when a stock's valuation is many time sales. At some point in time, gravity will pull these stocks down to Earth. It's just a question from what height.

Now let's look at two stocks that have been brought down to planet Earth by the force of valuation gravity.

RAX Chart
(Click to enlarge)

RAX data by YCharts

The first on the list (chart above) is high flying Rackspace (RAX). Just like similar stocks, it was trading (and still is) at high flying multiples, not only in terms of Price/Sales but by just about every metric you can imagine. At some point in time however something happened and the market didn't get exactly what it was expecting (or hoped for) and decided it was time to jump ship. So the stock lost about 50% in the blink of an eye, erasing more than two years of gains in no time.

BBRY Chart
(Click to enlarge)

BBRY data by YCharts

BlackBerry (BBRY) was once in the same situation. For some odd reason the market thought BlackBerry was a very cheap stock back in 2008 and 2009, propelling the stock to over $125 a share, when the company was booking about $2 billion per quarter. If you do the math, the Price/Sales of BlackBerry back then was about 15.

Today however, even if BlackBerry is booking about $3 billion in sales per quarter, the market has marked the shares down to about $11. The question is, will all those who bought BlackBerry at $100 or above ever see their money again? The answer is probably not.

The bottom line is, no matter how fast a company is growing, the risk of buying any company at a very high Price/Sales multiple is an invitation to lose money somewhere down the road.

Yes you might be one of the lucky ones who sell and cash out, but in order for that to happen, you have to be aware that you have bubble in your portfolio. Because if you do not realize this, then eventually you will be a bag holder.

As for ExOne, I highly advise selling it, and shorting it outright if you have a talent for doing so. But not because of the market's disappointment yesterday, but because it's a bubble.

And for those who decide to buy the dip, remember just how big of a bubble this stock is, because at some point in time it will keep falling and falling and falling, and you will think it's a bargain, just because at some point in time it was worth $75 a share.

And maybe just like BlackBerry today, it might become dirt cheap, but seeing your money again will be near impossible.

Source: Sell ExOne Because It's A Bubble, Not Because Of Market Disappointment