The Shocking Truth About 3D Systems Corporation's Valuation

No matter how you cut it, shares of 3D Systems (NYSE: DDD  ) are expensive on paper. While this may scare many investors into missing out on a great opportunity, Foolish investors aren't ones to automatically dismiss "overpriced" stocks from becoming the latest additions to their portfolios. After crunching the numbers, the longer an investor holds 3D Systems starting from today, the better the chances that they'll stand to make a profit over the long term.

Setting the baseline
On a high level, 3D Systems is the Amazon.com of 3-D printing, aggressively investing to improve its long-term business prospects. The company has been deploying heaps of cash to make acquisitions, grow market share, and improve its technology. Consequently, 3D Systems' bottom-line earnings power is likely to remain constrained for the foreseeable future. This is why it's better to evaluate 3D Systems by how much investors are willing to pay for its revenues.

DDD PS Ratio (TTM) Chart

DDD PS Ratio (TTM) data by YCharts.

The chart above looks at 3D Systems' price-to-sales ratio, which divides the company's market value by its trailing-12-month revenue. The large uptrend indicates that the price of 3D Systems' stock has been growing significantly faster than its revenues. Compared to the S&P 500's price-to-sales ratio of about 1.7, it's safe to say that 3D Systems investors are paying a significant premium for its revenues. In fact, there are only a handful of publicly traded companies that have a higher price-to-sales ratio than 3D Systems.  

Getting realistic
You could easily argue that 3D Systems deserves to trade at a high premium to the market because 3-D printing offers tremendous disruptive potential to revolutionize how the world designs and manufacturers, and 3D Systems is a leading company in the space. However, investors should still expect that 3D Systems' price-to-sales multiple will eventually contract to a level more in line with companies or industries that have similar revenue growth trajectories and characteristics.

Over the last five years, Google has grown its revenues by nearly 18% per year, and over the next five, analysts expect revenues to grow by another 17% per year. Like 3D Systems, Google enjoys being a leader in its space and is often described as a disruptive company. Assuming 3D Systems can grow its revenues by a similar long-term growth rate, Google's current price-to-sales ratio of roughly 7 seems like an appropriate ballpark valuation estimate for 3D Systems. Of course, Google and 3D Systems are completely different businesses with different models and profit margins, but what unites these businesses is their ability to disrupt the status quo. Because the market often assigns premiums to industry disruptors, the likelihood exists that 3D Systems will continue to trade at some kind of premium to the market. 

Source: 3D Systems. 2014 midpoint and 2015 estimates provided by company.

While this may seem like a conservative estimate based on 3D Systems' current revenue trajectory, the 3-D printing industry as a whole is expected to grow by about 19.3% a year through 2021, and analysts expect 3D Systems to grow its revenues by about 23% per year over the next five years. Additionally, 3D Systems has made nearly 50 acquisitions in the last three years to help drive stronger revenue growth. Investors should probably discount this historically strong revenue growth rate to some degree.

The road to profit
In order to offset a price-to-sales multiple compression and corresponding falling stock price, 3D Systems' full-year revenue needs to grow in proportion to the compression. If 3D Systems manages to grow its full-year revenues faster than an ensuing price-to-sales multiple compression, investors will generate a positive return.

The presentation below outlines three different price-to-sales multiple compressions, each with four different desired long-term returns, and also the compounded annual revenue growth rate needed for investors to make a desired return, assuming they bought 3D Systems today and held through a specified year.

 

Source: Author's calculations. Dollars in millions.  

It quickly becomes apparent that the longer 3D Systems shares are held, the less 3D Systems has to grow its revenues to generate long-term returns for investors. Historically, 3D Systems' acquisition strategy has helped it generate incredibly strong revenue growth and the company's future revenue estimates suggest this will likely continue in the years ahead. In other words, it isn't entirely out of the question for 3D Systems's long-term return to be 10% to 15% or more per year over the next decade. The magic of compounding would turn today's $60 stock into a $155 or $240 one.

A friendly reminder
If 3D Systems price-to-sales ratio were to compress from 11 to four and revenues remained at 2013 levels, investors would lose 64% of their initial investment. Although 3D Systems’ current revenue trajectory makes this “doomsday” scenario seem highly unlikely, there are unfortunately no guarantees when it comes to investing. It’s crucial for investors to understand that if 3D Systems grows its revenues at a rate slower than a price-to-sales multiple compression over a specified period, investors will face losses. The severity of these losses will be determined by a combination of the rate of compression and 3D Systems’ corresponding (if any) annual revenue growth.

Buying shares of 3D Systems at today's levels is really a vote of confidence in the company's ability to significantly grow revenues over the long term, and that the risk you're taking is less than the potential reward. Regardless of how confident you are in 3D Systems' ability to drive future revenue growth, never buy more than you're comfortable losing if 3D Systems lost 100% of its value.

Pulling the trigger
If 3D Systems' acquisition strategy continues far into the future, it'll make it even easier for the company to drive long-term revenue growth fast enough to more than offset a major price-to-sales multiple contraction. The evidence already suggests that 3D Systems is making the right kinds of acquisitions, so there's currently little incentive for this strategy to change.

Of course, a big portion of 3D Systems' future returns are going to be dependent on what investors are willing to pay for its revenue growth -- and anything is possible when it comes to investor sentiment. Investors may grow tired of 3D Systems' acquisition strategy, but the backstop of strong industry growth builds a margin of safety into 3D Systems' revenue trajectory and gives investors more confidence to endure the ups and down for the long haul.

Naturally, Foolish investors won't let this "expensive stock" get in the way of what appears to be a great long-term opportunity.

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Read/Post Comments (21) | Recommend This Article (45)

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 March 25, 2014, at 1:39 PM, PRODOD wrote:

    The only "shocking truth" is that your strained attempt to justify the valuation of DDD makes you sound like the worst of the dot com hucksters.

  • Report this Comment On March 25, 2014, at 4:59 PM, AuTiger wrote:

    I'm hesitant w/ 3d especially with Hewlett Packard joining the mix and Strats already dominant influence but I like that they partnered with Canon and I do think ddd will be good long term.

  • Report this Comment On March 25, 2014, at 5:01 PM, spinindog wrote:

    Prodod, send your comment to FutureMe.org

    It will be an interesting read on the holographic viewing device that you printed out.

    Then you can entertain your kids with stories about having things "shipped" to your house in only 2 days!!!

  • Report this Comment On March 25, 2014, at 5:40 PM, xetn wrote:

    It is totally irrational to even consider buying a way over-priced stock with the stupid idea that if you hold it long enough you can make a profit. What ever happened to the idea of buy low sell high?

    TMF is getting more ridiculous every day.

  • Report this Comment On March 25, 2014, at 5:52 PM, kajunfool wrote:

    try using Buffet's way to decide.

  • Report this Comment On March 25, 2014, at 5:59 PM, user5701 wrote:

    You all do know that it's down about 40% YTD, right?

  • Report this Comment On March 25, 2014, at 6:00 PM, AmericanExports wrote:

    I have no problem saying that I have made more money with Foolish stocks than I have been paid for work or in business for over 35 years of work.

    So with that out of the way. I think it would be wise for MF to factor in potential competitors like HP (as vaporious as that is right now, and notwithstanding how HP ruined their own rise to glory the 2D printing business).

    My view is that 3D printing and MMA will grow so fast over the next few years that this type of so-called competition will actually only spur more interest and innovation in a technology that is yet to actually bloom. My analogy would be this is like someone in 1978 saying Don't buy APPL because MSFT is going to bury them. OR... Don't buy MSFT, IBM will crush them... It never fails, some people don't catch on until it's on the cover of Time Magazine, but that's the time you might want to take some profits. When you have SHORT SHORT SHORT DIVE DIVE DIVE on the cover of Barrons, well then it might be a buy signal... as it was for me. Now that's not "contrarian" it's an understanding how how BIG players do things. IF they want to get in to something they will push the price down so they can pick up shares... and then when they want to sell, then the headlines suddenly read that it's the greatest thing since sliced bread. Even if you go by the Barrons story... consider this... they said that the industry would be very profitable in 2 to 3 years. Seriously, is that when you want to accumulate shares... when it's totally obvious to everyone?? There is nothing in conflict between Barrons projections and MF's projections... The question is, if you want to go long; do you go long after the shares have doubled 6 times, or do you go long now?

    If BIG FAT Mature companies like HP are so competitive... then how is it that companies like APPL or MSFT ever when from Garages to Mega Billion Dollar corporations? And then Even companies like MSFT got totally blindsided by the INTERNET of all things! Companies like AOL came out of nowhere and became Mega Billion Dollar enterprises. GOOG came out of nowhere and made MSFT's head spin. WHY? Think about it.

  • Report this Comment On March 25, 2014, at 7:01 PM, Goldbugg wrote:

    The not so shocking "truth" is that during the next major correction this is one of several high flyers that will come crashing down like a lead brick. If you are inclined to buy this one, keep it on you watch list and scoop it up for 70-80% less after that happens.

  • Report this Comment On March 25, 2014, at 8:06 PM, chris293 wrote:

    How can this stock be badmouthed at the same time EPS is estimated to be going up over 50% next year from a estimated EPS increase of only something like over 20-25% this year. Oh, the poor stock, either 'Hype and Dump' or 'Scare for Sales', some will win while other become losers. The stock market is a game of chance where it pays to be smarter than most people putting their money on the line. 3D Systems numbers look good but are estimates. Do your homework!

  • Report this Comment On March 25, 2014, at 8:09 PM, DanLu59 wrote:

    I could see this as a speculative play only and not an investment. For those trying to grow and build a portfolio it's too risky. If you don't need any money but like excitement, this will do.

  • Report this Comment On March 25, 2014, at 8:30 PM, brandonchen wrote:

    You kept on saying holding the stock long-term. How long is long term? 5 years, 10 years? What investors have missed was the 30% downside on DDD when you started telling investors to buy at 80-90s!!

  • Report this Comment On March 25, 2014, at 8:37 PM, fuzzy441037a wrote:

    anyonr willing to pay 11.06 p/s is a fool and is speculatin,not investing

  • Report this Comment On March 25, 2014, at 10:13 PM, TMFBiggles wrote:

    The most important sentence here seems to be this one:

    "Of course, a big portion of 3D Systems' future returns are going to be dependent on what investors are willing to pay for its revenue growth -- and anything is possible when it comes to investor sentiment."

    Investing based primarily on sentiment is speculation, isn't it?

    - Alex

  • Report this Comment On March 25, 2014, at 11:42 PM, TMFTopDown wrote:

    Alex,

    This exercise is about whether it’s realistic for 3D Systems to generate enough revenue growth to make a positive return for investors in the event that Mr. Market decides to change its mind on 3D Systems and assign it a much lower valuation.

    I’m merely acknowledging that we don't know how Mr. Market will feel about 3D Systems in the future, so we don’t know what investors will be willing to pay for its revenues then. What we do know is that 3D Systems has a strong history of revenue growth and the prospect of solid industry growth (19.3% per year through 2021) in the future. Ultimately, these characteristics give investors a higher degree of confidence that 3D Systems can generate the necessary revenue growth to more than offset if Mr. Market decides grow sour towards 3D Systems’ valuation at some random juncture in the future. The further away this juncture, the easier it will be for investor to generate a positive return.

    Cheers,

    Steve

  • Report this Comment On March 26, 2014, at 12:55 AM, OverSouled wrote:

    In the event of a significant economic downturn in the next few years (of course that never happens) I'm afraid that Motley Fools who buy into manufacturing companies with exorbitant multiples will look like regular fools (but without the shirt).

  • Report this Comment On March 26, 2014, at 1:48 AM, brandonchen wrote:

    Is this what we paid our subscription fee to MF for? Speculating instead of investing...This is increasingly becoming speculating...

  • Report this Comment On March 26, 2014, at 5:39 AM, run66 wrote:

    Personally, I think you need to look at their product(s) to determine whether or not they are a good investment, and I'm sorry to say, I'm skeptical! 3D technology - Great for manufacturing PLASTIC products, BUT not so great for assembling anything other than plastic - in my mnd! I wonder how you manufacture a "metal" product using 3D technology? Plastic will mesh together with this technology, BUT I wonder how well metal will mesh together unless it's done at a high temperature? Will the product need to be "tempered" after it's assembled 3D fashion? And, how do you control metal assembly to tight tolerances?

    Given these questions, I think I'll pass right now on 3D and their technology. As I said, GREAT for plastic - as in toys - but still unproven to me for any other use!

  • Report this Comment On March 26, 2014, at 8:16 AM, AuTiger wrote:

    AmericanExports nice perspective.

  • Report this Comment On March 26, 2014, at 9:10 AM, mainelefty wrote:

    There was never a time when Google, Priceline, Middleby, Netflix, Panera, Chipotle or many others was cheap using conventional metrics.

    If you're only evaluating based on these, there's little reason to own anything but Berkshire Hathaway or SPY. And you never need to think about a PEG ratio.

    The issue isn't whether sales growth will slow, it will. And price to sales as a metric is close to useless in the long run. My issue with DDD and EXONE and SSYS is what I call the Commodore factor - in 1980, if you wanted to buy the biggest personal computer company in the world, with the most units sold, that was Commodore.

    Not, as it turns out, a good choice.

    So the question is, in MF terms, (or Buffett terms) "what is DDD's moat ?"

    Now that it's down 40% from an unsustainable leap in the last few quarters, it's probably worth trying to understand.

    And remember Tom E "Only buy a little. If it's great, that's all I need. If not, that's all I want."

  • Report this Comment On March 26, 2014, at 11:37 AM, zgriner wrote:

    As a conservative investor who buys dividend-paying stocks, I am confused about putting money into a stock like this as an INVESTMENT vs SPECULATION.

    Are you buying a business or a stock?

    As I see it, these companies go deep into debt, spending every penny to fund the next round of products to sell. So if the merry-go-round stops, you have nothing to show for it. So, from my point of view, you are buying a stock.

  • Report this Comment On April 02, 2014, at 1:25 PM, TMFCatoMinor wrote:

    "There was never a time when Google, Priceline, Middleby, Netflix, Panera, Chipotle or many others was cheap using conventional metrics.

    If you're only evaluating based on these, there's little reason to own anything but Berkshire Hathaway or SPY. And you never need to think about a PEG ratio."

    Really all that needs to be said. Nice summary, mainelefty.

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