Axon Enterprise (NASDAQ:AAXN) has a leading position in the attractive markets for electroshock weapons and body cameras, but it hasn't been able to translate that strength into reasonable stock market performance. Over the last three years, while body camera sales have taken off, Axon's share price has risen just 8.2%, while the S&P 500 is up 39.3%. 

One big reason for the stock's underperformance is that Axon's profits have gone down even as sales have grown. Management's decision to invest heavily in developing and selling new body camera products took a bite out of the bottom line, but they're spending money with the hope that long-term the investment will pay off. In 2018, a financial return needs to start to reveal itself

Officer with body camera talking to a witness.

Image source: Axon Enterprise.

Spend money to make money

The chart below gives a good outline of why Axon's stock has lagged the broader market for the last three years. Margins are down, particularly the operating margin, which is at an unsustainably low level. 

AAXN Return on Assets (TTM) Chart

AAXN Return on Assets (TTM) data by YCharts

If these trends continue, it will be troubling for Axon Enterprise. But there's reason to think the company will deliver a sharp turnaround in its financial results in 2018. In fact, all three of the trend lines above could turn positive this year. 

How to turn Axon Enterprise's stock around

Here are the key things Axon must do to turn around the operating metrics above and, by extension, improve the stock's performance. 

  • Sales growth outpacing operating expense growth: Management said it is working to "adjust the trajectory" of operating expense growth, but investors will need proof before they can believe operating leverage will begin working in Axon's favor. 
  • Increase high-margin cloud and services revenue: Axon's services can reach gross margins over 80%, which should raise margins overall as low-margin hardware sales become a smaller percentage of sales. 
  • Launch incremental value-add products: Records management, Signal Sidearm, artificial intelligence services, and car fleet video products are expected in 2018 and should help expand revenue from existing customers. If new products are successful, they could fuel both top line and bottom line growth without the need for increased operating expenses. 
  • End subsidies for subscription contracts: Early sales for subscription of body cameras and tasers were often highly subsidized, a practice management says it's going to reduce in 2018. Axon needs to prove subscriptions come with a sustainably high gross margin, rather being money-losers long term. 

These margin expansion measures need to be implemented at the same time as Axon continues to grow its core taser and body camera businesses. Millions of law enforcement officers around the world are still without body cameras, and as an industry leader, Axon would like to get its devices and services to every one of them. If Axon can keep its sales momentum strong and begin to expand the bottom line, it could be a home run stock for investors in 2018. 

Travis Hoium owns shares of Axon Enterprise. The Motley Fool owns shares of and recommends Axon Enterprise. The Motley Fool has a disclosure policy.