Stratasys Ltd. (NASDAQ:SSYS) reported solid first-quarter earnings last week, but shares have yet to rally on the results and remain down 33% year to date. Stratasys shareholders and interested investors can find an excellent breakdown here in this deep dive into Q1 earnings.

Today, I'm going to focus on the valuation of Stratasys to determine if it looks like a good investment from a relative valuation standpoint after the recent sell-off.

Relative valuation... what is that?
Before delving into relative valuation, it's important for all investors to understand what causes a company's stock price to increase or decrease 

For most investors, they'd typically like to see a stock price go up, but what specifically causes a stock price to increase? For simplicity's sake, two criteria generally affect share price over the short and long term -- company performance and how the stock market feels about that performance.


Image courtesy of Stratasys

A company's performance is looked at through a variety of metrics, but sales and earnings are the most popular for a company like Stratasys. For example, Stratasys generated $538 million of sales over the last 12 months and has grown those sales by 37% a year over the last five years. For this awe-inspiring performance, the stock market has decided investors have to pay eight dollars for one dollar of sales at Stratasys; in other words, the company has a price-to-sales multiple of eight. When we multiply the price-to-sales multiple by yearly revenue, we get Stratasys' market capitalization of $4.4 billion, or $89.25 per share. 

As investors can see, the price is equal to how the company is doing (sales) multiplied by how the market feels about those results (price to sales). The concept that investors really want to focus on is the fact that it takes a company months or years to change operating results, but feelings can change overnight. So, in both the short and long terms, how the market feels can be a very large driver of a stock's price.

There are several ways to calculate a relative valuation, but for this case we'll look at a scenario in which multiples contract due to decreased expectations from the stock market. Then we'll look at what rate of revenue growth would be needed to offset the contraction of the multiples and still generate a satisfactory return for shareholders. 

Enough already! Is Stratasys a good buy or not?
Now that investors are familiar with how a company's stock price is determined from day to day, the relative valuation can commence. In the video below, Motley Fool analyst Blake Bos will dive head first into a scenario that could give investors an 8%-12% yearly return over the next five years, and then explain why he thinks it could be a likely scenario. He'll also tell investors why he's still not sure about investing in Stratasys today, and offer insight into how investors should look at the company. 

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Blake Bos has no position in any stocks mentioned. The Motley Fool recommends Stratasys. The Motley Fool owns shares of Stratasys. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.