Why This Laser-Maker's Sell-Off Shouldn't Worry You

In mid-February, fiber-optic laser maker IPG Photonics (NASDAQ: IPGP  ) came out with earnings that disappointed Wall Street investors. Shares traded down immediately following the release, and now sit at a 17% discount to where they were just a few weeks ago.

Below, I'll tell you why I'm not worried about this stock, and why I'd even consider adding shares at this point. Read all the way to the end and I'll also include access to a special free report on three stocks to help you retire rich.

Filling in the back story
IPG Photonics is a fully integrated company that provides fiber-optic lasers that are used in several industries, but none moreso than heavy machinery and welding. The company's lasers are smaller, more energy efficient, reliable, and powerful than their carbon-based counterparts. In short, the company's technology would definitely qualify as a disruptive innovator

For the full 2012-year, IPG had nothing to be ashamed of. Revenue was up 19%, operating margins improved by 10 basis points, and earnings per share were up 17%.  Though most investors don't like seeing revenue growing faster than earnings per share, I'll explain why that's not too much to worry about.

Investors were also disappointed that the mid-point for first quarter earnings guidance was lower than what analysts were expecting.

Where's the money going?
A good way to understand how IPG stacks up next to its former self, and to its peers, is to look at how all of the revenue the company generates gets used.

Source: SEC filings. 

Now there are two key takeaways that I can see from this chart. The first is that research and development costs actually increased between 2011 and 2012 faster than revenue did. I'm 100% fine with that, though, as IPG's advantage is its superior technology, and if it wants to keep that spot, it needs to continue investing in development.

The second takeaway is that earnings per share should have been greater, as the percentage of revenue that translated into income was higher in 2012 than in 2011. The main difference, therefore, was that IPG increased the number of its shares by 6%. I'm not a fan of this, but if it's a one-time event, I can let it slide.

Stacking up against the competition
Though there are no other pure plays on companies focusing solely on fiber-optic lasers, the industry is getting more crowded as time goes on. Rofin-Sinar (NASDAQ: RSTI  ) , Coherent (NASDAQ: COHR  ) , and JDS Uniphase (NASDAQ: JDSU  ) all have fiber-optic lasers either in the works or on the market. But a look at how much revenue gets translated into income for these companies shows just how much ahead of the pack IPG is.

Company

Net Margin

P/E

IPG Photonics

26.3%

20

Rofin-Sinar

6.3%

21 

Coherent

7.7%

23

JDS Uniphase

(0.9%)

N/A 

Sources: SEC filings and Yahoo! Finance. N/A = Not applicable due to negative earnings

In other words, IPG is trading for about the same or slightly less than its competition. Yet, it is banking far more of every dollar it takes in -- the orange section in the pie charts above -- than the others.

But what do things look like going forward?
But the things above are just numbers; it's important to understand the story behind the company as well.

Looking ahead, the overall market for lasers is only expected to grow by 6% in the coming years. But the market for fiber-optic lasers -- which IPG is the clear leader in -- is expected to grow by 23% in the same time frame. These numbers are even more encouraging when you consider that IPG has a 70% market share for fiber-optic lasers.

Though much of the growth will come from high-power lasers used in materials processing, two markets that IPG hope to get into soon are the fine processing and non-metal markets. 

Most important from a competitive standpoint is the fact that IPG's cost per watt in producing its own diodes has come down significantly. Because the company is vertically integrated and completes this work in-house, this is a huge competitive advantage over any company trying to enter the fiber-optic laser market.

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