Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

Less than two years old on the public markets, ShotSpotter (SSTI 0.61%) stock has gone on a tear. But is its run now done?

Since going public, shares of the gunshot-detection system-maker have more than quadrupled off their $11 IPO price. In fact, up until a month ago, ShotSpotter stock had roughly quintupled, approaching $55 -- but that was before earnings happened.

Flashing blue lights on a police car at night

Image source: Getty Images.

What happened to ShotSpotter?

The self-proclaimed "leader in gunshot detection solutions" reported its financial results for fiscal Q1 2019 last week. Sales surged 39% year over year to $9.6 million -- but were flat sequentially -- and the company lost $0.03 per diluted share.

Although this loss was just one-third as big as last year's $0.09-per-share loss, the result nonetheless fell short of analysts' prediction of a $0.02-per-share loss, and the quarter is being called an "earnings miss." (Sales missed estimates, too.) Regardless, one analyst -- Imperial Capital -- is sticking with its $49 price target on ShotSpotter stock. What's more, with shares now 17% cheaper after earnings than they were before them, Imperial has decided to upgrade ShotSpotter to outperform.

Why upgrade ShotSpotter?

Upgrading ShotSpotter after an earnings miss may be a controversial call, but as Imperial Capital sees it, ShotSpotter's miss wasn't really the disaster that investors appear to be making it out to be.

Granted, ShotSpotter lost $0.03 instead of the $0.02 analysts expected in Q1. This will now make it a bit harder for ShotSpotter to reach analysts' $0.08-per-share earnings target for the end of this year. But even if ShotSpotter ends up only earning $0.07 this year, instead of the $0.08 analysts predict, this would still be a positive profit for the company -- and its first year earning a positive profit. 

What's more, even the earnings that ShotSpotter reported were "roughly consistent" with what Imperial had predicted the company would earn in Q1, reports TheFly.com. And despite the loss of one customer and delays in signing up two more last quarter, and reducing revenue guidance for the full year by $1 million, StreetInsider.com (subscription required) quotes the analyst remaining "relatively positive on the company's growth and profitability outlook" going forward.

Gauging ShotSpotter's prospects

So what does that outlook look like?

According to a poll of analysts conducted by S&P Global Market Intelligence, ShotSpotter is likely to turn GAAP earnings positive by the end of this year, then quintuple those profits to $0.49 per share in 2020. Over the succeeding two years, analysts see ShotSpotter quadrupling its profits again, to earn $1.99 per share in fiscal 2022.

The company is already generating positive free cash flow -- just a hair under $3.4 million over the past 12 reported months, and S&P Global data shows analysts predicting that ShotSpotter will nearly double that figure to nearly $6 million by the end of this year. Helping to grow profits, says Imperial, is the company's recent acquisition of "AI based analytics for predictive policing" software maker HunchLab, the products of which will yield "likely better margins than core ShotSpotter."

In its post-earnings conference call with analysts, the company noted that it's currently hard at work integrating HunchLab's analytics software with its own, and as a result expects "to formally introduce our first ShotSpotter based Mission's release to the market later in Q2 of this year" -- which means we could begin to see those better margins filtering down to the bottom line in relatively short order.

What it all means to investors

ShotSpotter's earnings miss last week -- and the 17% share-price drop that followed -- probably took the wind out of the sails of a lot of ShotSpotter investors. That being said, this is still a small company, one with a lot of room to grow, and one that is in fact still growing -- again, sales growth: 39%. Until a final solution to the epidemic of gun violence in America is found, ShotSpotter has an opportunity to become at least part of the interim solution.

Even so, I would have to advise investors to be cautious regarding the price they pay to be part of this growth story. Although 17% cheaper today than it was a week ago, ShotSpotter still sells for a rich 14 times sales -- and for more than 150 times trailing free cash flow. Still, if the company succeeds in turning GAAP-profitable this year, then growing earnings 25 times over the next three years (as analysts predict), it's possible even these rich valuations could turn out to be bargains.

But personally, I wouldn't mind seeing a bit more margin of safety in the stock price before making that bet.