Is Stratasys' Stock Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Stratasys (NASDAQ: SSYS  ) fit the bill? Let's look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Stratasys' story, and we'll be grading the quality of that story in several ways:

  • Growth: Are profits, margins, and free cash flow all increasing?
  • Valuation: Is share price growing in line with earnings per share?
  • Opportunities: Is return on equity increasing while debt to equity declines?
  • Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at Stratasys' key statistics:

SSYS Total Return Price Chart

SSYS Total Return Price data by YCharts

Passing Criteria

3-Year* Change 

Grade

Revenue growth > 30%

172.3%

Pass

Improving profit margin

(728%)

Fail

Free cash flow growth > Net income growth

(165.9%) vs. (364.3%)

Pass

Improving EPS

(183.6%)

Fail

Stock growth (+ 15%) < EPS growth

210.7% vs. (183.6%)

Fail

Source: YCharts and Morningstar.
*Period begins at end of Q1 2010.

SSYS Return on Equity Chart

SSYS Return on Equity data by YCharts

Passing Criteria

3-Year* Change

Grade

Improving return on equity

(145.1%)

Fail

Declining debt to equity

No debt

Pass

Source: YCharts.
*Period begins at end of Q1 2010.

How we got here and where we're going
This isn't a particularly good showing for such a popular stock, and a big reason for that is the big decline in net income seen over the last few quarters. However, free cash flow hasn't been doing well, either. Stratasys began the tracking period with positive free cash flow, but has since sunk into the red there. There's a great deal of optimism surrounding 3-D printing, but the actual results don't always match up to the hype. Stratasys also significantly underperforms its sector peer 3D Systems (NYSE: DDD  ) , which earned five out of seven passing grades on this analysis late last year. But is this just a temporary blip, or indicative of long-term earnings weakness?

Stratasys bulls will point to its adjusted earnings, which came in 40% higher in the most recent quarter than the results of a year ago. There's a great deal of divergence between the adjusted numbers and the official reports, and with analysts all tracking the former, it becomes easier to dismiss the latter as nothing more than a quirk of accounting rules. However, investors shouldn't ignore Stratasys' free cash flow, either -- operating cash flow was barely positive last year, and free cash flow results have been shrinking for several years now. A growing company needs to spend on expansion purposes, this is true, but if this expansion turns out to be more optimistic than the market realities, then investors wind up buying into a stock that's growing beyond its fundamentals.

Another risk to Stratasys' growth is a potential patent fight over some key 3-D printing processes. Many of the core 3-D printing technologies Stratasys and 3D Systems developed 20 years ago are, well, 20 years old now -- patents on more specific technologies can help extend a grip on the market, but there's little either company will ultimately be able to do to keep that grip in the face of competition. The only answer is to out-scale or out-innovate smaller players. Scale is easy so far, especially after Stratasys' merger with Objet, but if the 3-D printing market will truly grow as fast as projected, it's quite likely that we'll see much larger industrial players before long.

Putting the pieces together
Today, Stratasys has some of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.

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