TASER'S AXON BODY AND FLEX CAMERAS. IMAGE SOURCE: TASER INTERNATIONAL.

By all accounts, stun-gun maker TASER International (AXON -1.34%) enjoyed fantastic sales in the second quarter. And yet, the stock's share price has hardly budged, up less than 2% since the company reported its results. Why?

The news

For fiscal Q2 2016, TASER reported:

  • Sales growth of 26%, to $58.8 million.
  • But declining gross profit margins on those sales, down 230 basis points to 63.4%.
  • Operating profit margins that collapsed by nearly half to 10.6%.
  • And on the bottom line, just $0.07 per share in net profit -- down 37% year over year.

Simply put, while TASER did a great job moving product last quarter, it did a less-than-great job of converting those sales into profits. Revenue from the company's booming business in Axon-brand police body cameras exploded 49% higher in Q2, while sales from the company's core business selling Taser-brand stun guns increased a very respectable 20%. And right there you can see the secret to TASER's (lack of) success (in growing profits) in Q2.

As TASER plainly states, "the decrease [in both margins and profits] was primarily due to a mix shift to Axon segment hardware revenue." Unfortunately, while Axon sales are booming, the company only earns about 47% gross profit margin on those cameras. The less active growth in stun guns, on the other hand, produces a 68% gross margin for TASER.

So, simply put, TASER makes more money selling stun guns than cameras -- but it's the camera business that is growing faster, and that growth is dragging down the profitability of the company as a whole.

The turnaround cometh

So when do things get better for TASER? Management actually gave us a clue to the answer this month as well. Namely, the company noted that while Axon gross margin may be inferior to gross margin on Tasers, the gross margin from selling Evidence.com storage of data collected from Axon cameras is superior to margins found anywhere else in the company -- 71%.

And that, if you ask me, is the real secret to understanding TASER. Think of Axon as a sort of loss leader for the company -- or for longtime investors, as the low-margin "razor" which permits sale of high-margin "blades." The more low-margin Axons TASER puts on the market, the more high-margin Evidence.com revenue the company can reap from Axon users down the line. Ultimately, the hope is that high-margin services revenue will outweigh low-margin hardware revenue, and get TASER profits growing again.

Valuation

Is that a hope worth betting on? Well, analysts who have taken a close look at TASER's business model and its projections see TASER stock growing its profits at about 30% annually over the next five years (according to data from S&P Global Market Intelligence). Weighed against the company's P/E ratio of 112, that suggests that even at 30% growth, TASER stock is vastly overpriced. On the other hand, weighed against the company's more reasonable-sounding ratio of price-to-free cash flow, 39, it's... somewhat less overpriced.

Either way, I have to agree with the investors who are passing on the opportunity to own TASER stock this month. In my view, the stock is simply not cheap enough to buy.