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All of us who trade stocks full time have heard the old adage: “cut your losses short and let your winners run”. It’s definitely a cliché, but this simple sentence encapsulates what a trader needs to internalize in order to survive in this business. A disciplined trader can be wrong 80% - 90% of the time and still make money. No trader is correct all the time so the idea is to exit a poor trade early with a small loss and to ride your winner(s) to big gains. One 5 or 10-bagger makes up for a lot of mistakes. The concept is simple to understand but very difficult to consistently execute.

So what defines a winner? It depends on who you ask. High frequency traders would have a different definition than a “buy and hold” investor. Personally, I am a position trader so I will maintain a trade as long as the stock, its industry, sector and the market all continue to behave themselves. My holding period may be less than one day to a year or more.

The Holy Grail for me is a situation where I identify a company on the cusp of a major economic revolution. This doesn’t happen very frequently so it’s a short list (at least since the 80’s): Microsoft (NASDAQ:MSFT) / Intel (NASDAQ:INTC) in the PC revolution; Cisco (NASDAQ:CSCO) in the internet revolution; Apple (NASDAQ:AAPL) in the consumer IT space and Google (NASDAQ:GOOG) in internet search (I’ll add Facebook when it debuts if its ROC is >= 17%). With the exception of Google, all of these companies were small caps for a period of time after their IPOs. No one forecasted them to be as big as they would eventually become. All, though, delivered fantastic multi-year bull runs as they rode their respective mass adoption waves. AAPL, in fact, isn’t finished yet in its current run.

Major economic revolutions, as I define them here, are driven by products or services that totally upend the pervasive business models. The cost advantages that they deliver are so great that customers literally fall all over themselves to get on board. This is why all of these innovative companies are wildly profitable during their bull runs. They can literally dictate their market prices.

Are there any of these technological revolutions emerging today? One can never know how large an emerging trend will eventually become, but I’m tracking 6 areas that I believe represent enormous growth potential for astute traders: Automated Retail, Internet Things, Robotics, Smart Systems, Synthetic Biology and 3D Printing. The last area is the one I address in this posting.

Three dimensional printing has been in use for the past 10 – 12 years. The technology seems futuristic but it is performed in the same way you would send a digital file to your office printer. In this case, the ink is a material (e.g., high grade thermoplastics or carbon fiber composites) that is deposited in successive thin (20 – 30 microns) layers until a solid object is formed. The layers are defined by software that takes a series of digital slices through a computer-aided design (CAD).

The material can be applied in several ways. For example, powder can be put into a tray and then solidified into a design with a squirt of a liquid binder or by sintering it with a laser or electron beam. Another approach is to deposit filaments of molten plastic.

The initial use of the technology was for rapid prototyping. Historically, this process has been expensive, labor intensive and time consuming. 3D printing and CAD software have made a profound impact on this process. Design changes can be easily made into the CAD and a new prototype can be produced literally in a matter of hours. Product development teams can now test a wider variety of designs in a much shorter time frame and at a much lower cost. It’s easy to see why the technology has enjoyed robust adoption throughout much of the world.

The exciting news is that there have been many product innovations in the 3D printers during the past 10 years or so. They are cheaper to purchase and operate, they are faster, they can produce a broader spectrum of products and they can apply a wider array of materials. The use of these systems has now evolved beyond rapid prototyping into actual production. It’s called “additive manufacturing”.

The economics of this evolution are extremely attractive. We’ve all heard the buzzwords “mass customization”, but now it is truly a reality. 3D printing eliminates almost all of the risk in making changes to products. Retooling costs have dropped close to zero and material waste is virtually eliminated. Manufacturers can literally produce thousands of custom products at a time at lower costs than traditional batch run processes. This has the potential to transform the manufacturing process.

Current examples of products being produced by additive manufacturing are: titanium aerospace parts, medical implants, jewelry, football shoes for individual feet, lampshades, dental crowns, racing car parts, solid-state batteries and customized mobile phones. Some companies have already achieved cost parity with 1000-unit (injection molding) production runs.

The airline industry offers a superb example of how 3D printing can impact its cost structure. Even small airplanes contain several tons of expensive titanium parts. Historically, these are machined from solid billets of metal. The waste material can be as high as 90% and it is not reusable. A 3D printer uses titanium powder to make the part. Material costs are only 10% of what would typically be needed and any unused powder can be recycled. In addition, machined parts usually contain excess material that has no functional role but is necessary for the production process. With 3D printing, there is no such excess.

Additive manufacturing has the potential to be truly transformative. Two companies that are well positioned to capitalize on this revolution are Stratasys, Inc. (NASDAQ:SSYS) and 3D Systems Corp. (TDSC).

Both companies offer an impressive lineup of printers for a variety of workplace environments. Stratasys looks like they are ahead of 3D Systems in the additive manufacturing space in light of their FORTUS production systems. These printers can produce large pieces at a production line speeds. 3D Systems lineup consists mainly of rapid prototyping systems. Two printers, the ProJet 5000 and ProJet 6000, look like they are the company’s first steps into true additive manufacturing.

Let’s look at some of the numbers for both firms:

SSYS

TDSC

Valuation Measures

Market Cap

970M

1130M

Enterprise Value

996M

1170M

Trailing P/E

105.9

58.1

Forward P/E

41.6

25.8

PEG Ratio

2.3

2.3

Price/Sales (ttm)

8.5

7.3

Price/Book (mrq)

6.8

8.8

EV/Revenue (ttm)

8.2

7.34

EV/EBITDA (ttm)

36.2

42.3

Profitability

Profit Margin (ttm)

7.70%

12.24%

Operating Margin (ttm)

15.10%

13.09%

Mgmt Effectiveness

ROA (ttm)

7.00%

7.28%

ROE (ttm)

6.70%

16.45%

ROC (ttm)

6.70%

14.60%

Income Statement

Revenue (ttm)

122.1M

159.9M

Rev/share (ttm)

5.93

6.93

Qtrly Rev Growth (yoy)

28.70%

41.60%

Gross Profit (ttm)

46.4M

74.0M

EBITDA (ttm)

27.5M

27.7M

Net Income (ttm)

9.4M

19.6M

Diluted EPS (ttm)

0.44

0.83

Balance Sheet

Total Cash (mrq)

36.4M

37.4M

Total Cash/Share (mrq)

1.75

1.59

Total Debt (mrq)

0

8.3M

Total Debt/Equity (mrq)

n/a

6.2

Current Ratio (mrq)

3.3

1.74

Book Value/Share (mrq)

7.31

5.70

Cash Flow

Operating CF (ttm)

24.5M

31.8M

Cash Flow/Net Income

2.61

1.62

Sources: Yahoo Finance, MSN Money, my own calculations

The companies look fairly similar although TDSC is more efficient. Both have CF/NI ratios greater than the minimum of 1.2 (this is a metric I place a lot of value on). Healthy companies should always be generating at least 20% more cash than their reported income.

Now let’s take a look at more metrics per Investors Business Daily (Investors.com).

Stratasys and 3D Systems are 2 of 11 total companies in the Machinery – Materials Handling/Automation industry group. The industry is currently ranked #4 out of 197 groups (A+ rating) tracked by IBD.

SSYS

TDSC

Composite Rating

98

99

EPS Rating

81

81

Relative Strength Rating

96

99

SMR Rating

B

A

Acc/Dis Rating

B+

B+

EPS Change (mrq)

50%

150%

#Qtrs EPS Acceleration

0

0

EPS Est. % Change

28%

211%

Estimate Revisions

Up

Up

Last Qtr EPS % Surprise

23.5%

53.8%

3-yr EPS Growth Rate

-15%

n/a

Current EPS Yr Est

36.5%

67.5%

Sales % Change (mrq)

29%

42%

3-yr Sales Growth Rate

-4%

-4%

Annual Pre-tax Margin

8.4%

12.3%

Price vs 50-day EMA

21.3%

35.9%

50-day Average Volume

173.3k

137.8k

Up/Down Volume

1.9

1.2

% Ch in Fund Ownership

0%

20%

Qtrs of Incr Fund Ownership

1

1

Looking at these numbers, we have all kinds of good news. Both stocks are leaders in a leading industry, their sales and revenues are growing robustly, analysts have recently revised forecasted EPS growth up and both stocks are near the top of the entire universe of US-listed equities for composite rating (combination of sales growth, revenue growth and profit margin) and relative strength (the highest possible rating is 99). What’s not to like?

In short, both stocks are delivering robust fundamentals and the market is responding. An additional bonus is that both companies are in the early stage of what could be a long term bull run (note the 3-year EPS growth rates for both firms is -4%). Both stocks have a healthy tailwind behind them. This is an attractive situation indeed.

I see only one negative. Both stocks are thinly traded. SSYS averages only 173,000/day and TDSC a mere 138,000. I rarely venture into a trade at these low levels because of the inability to build a meaningful position and the difficulty in exiting (not to mention the volatility risk). My position limit is no more than 3% of the average daily volume, so in this case, I would be constrained to no more than ~5200 shares of SSYS and ~4100 shares of TDSC. Even these positions would be risky if the situation deteriorated. On a large gap down, the volume could literally dry up to near zero for a good chunk of the trading day. You might as well bend over and grab your ankles if you try to exit. You’ll pay dearly.

Is it a good time to buy if you want to enter into a modest position, say 100, 500 or 1000 shares? Unfortunately, the timing isn’t right to enter at present. Both stocks are well extended beyond valid buy points and they are well above their respective 50-day EMA’s (exponential moving average). In addition, the market is in a correction. You should only enter into a long position if the market is in a confirmed uptrend. I would wait until the market confirms AND for the price to revert to its 50-EMA before considering a move. This could take some time.

The course of action that I recommend is to put both stocks on your watch list and research both companies and “additive manufacturing”. I’m quite sure that you’ll be encouraged by what you’ve learned.

Additional sources: www.statasys.com; www.printin3d.com; “The Printed World”. The Economist. 12 February 2011: 77 – 79.

Recommended reading

How to Make Money in Stocks, by William J. O’Neil.
The Change Function, by Pip Coburn.
Seeing What’s Next, by Clayton M. Christensen.

Source: Stratasys, 3D Systems and the Next Technological Revolution