This Stock Is Maturing Into a Winner

When I was in fifth grade, a girl named Sarah Williams asked me to be her boyfriend. She was awkward and had braces; I said no. When she graduated eight years later, she was the bombshell every guy wanted. My mistake: not appreciating that everyone has awkward growing pains.

I thought of Sarah when Rosetta Stone (NYSE: RST  ) released its Version 4 TOTALe last week. Though the company, which just went public in April of 2009, has gone on a recent run-up in price, Rosetta is still trailing its summer highs by about 20 percent -- and it has plenty of room to grow.

First, why are investors worried?
Rosetta's second-quarter release offered plenty of reasons to panic in the short term:

  1. A second C-level executive announced he was leaving the company (after an earlier departure by the CFO).
  2. Though it crushed earnings expectations by 30%, Rosetta missed on revenues by about 8%, and guidance for the third quarter shows the company losing money.

What everyone should have been paying attention to ...
A key to great investing is to ignore the short-term noise and focus on the broader horizon. There were several pieces of information from the last quarter that should get us excited about owning this stock eight years from now (and not repeating the same mistake I made when I was 11).

  1. With the release of Version 4 TOTALe, Rosetta is taking steps to transition from a base of one-time buyers to lifetime subscribers, ensuring a steady stream of cash. This essentially mimics one advantage Netflix (Nasdaq: NFLX  ) had over Blockbuster, ultimately beating the latter into bankruptcy.
  2. The company is willing to endure short-term losses for long-term gains. It will be spending its cash to hire real-time language support coaches. This unique offering will be expensive, but will add value and help differentiate Rosetta from possible competitors.
  3. International sales accelerated at an enormous clip: 155% year over year. This represents a huge area for growth as international sales currently account for only 14% of total revenue.
  4. Institutional buyers are growing and diversified. Sales to institutional buyers grew 25% last quarter, year over year. These buyers come from the ranks of K-12 education, the Department of Defense, and multinational corporations, among others.

By bracing ourselves for some growing pains along the way, Rosetta Stone investors could be richly rewarded in the future.

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Rosetta Stone and Netflix are both Motley Fool Stock Advisor recommendations. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Brian Stoffel changed Sarah's name, not for her protection, but for his. He owns shares of both Rosetta Stone and Netflix. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Fool has a disclosure policy.


Read/Post Comments (4) | Recommend This Article (22)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 28, 2010, at 2:32 AM, jaketen2001 wrote:

    To talk about Rosetta and not mention competition? There is all sorts of new competition, on mobile devices (language pod.com), social media competion (livemocha.com). And Berlitz? Hello? did you tally up the current market for language services, the future? Does it even work?

  • Report this Comment On September 28, 2010, at 9:50 AM, brewersfan81 wrote:

    @jaketen2001-

    Valid points. Competition must always be taken into consideration. The fact is, however, that the recent downturn in RST's price didn't have as much to do with competition so much as it did with execs leaving and lowered guidance due to spending for the launch of Totale.

    Brian Stoffel

  • Report this Comment On September 28, 2010, at 4:56 PM, Seaquill7 wrote:

    Consider that this stock is way, way overbought. Especially by the Cramer pump. How can anyone open a position in this company at this point? It is 800% over the Nov 08 low. Great Run. But real, real tired now.

    Competition is going to take digital streaming revenue AWAY from NFLX. Sure they have a niche but it will diminish as viewers will want the latest downloads. Not the 'old stuff'

    IMHO this stock has to take a 25% nose dive before I'd take a serious look at the future. And why is the CEO selling so much of his stock at the toppy price. Perhaps he knows where it is going - DOWN DOWN DOWN.

    NFLX should be at the TOP of your short list.

  • Report this Comment On September 29, 2010, at 1:19 AM, Jaspers0Debt wrote:

    Excellent perspective on RST Brian, thanks for sharing!

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