Ark Invest is known for its focus on investing in disruptive technologies, and industrial software company PTC (NASDAQ:PTC) certainly fits the description. The stock is one of the top 10 positions in ARK's 3D Printing ETF (NYSEMKT:PRNT) largely due to its computer-aided design (CAD) software. However, there's a whole lot more to like about the company, not least its exposure to the so-called fourth industrial revolution, or Industry 4.0. Let's take a look at what that is and why PTC is such an attractive stock for investors.

Industry 4.0

If the third industrial revolution was characterized by the increasing deployment of automation and computerized systems, then the fourth can be defined by the usage of Internet of Things (IoT) connectivity and digitization. It doesn't stop there, because the massive amounts of data produced by using web-enabled devices and digitized factories means a huge opportunity for data analytics to improve the functioning of a physical asset.

A worker and equipment inside a digital factory

Image source: Getty Images.

For example, an automated physical asset, say bottling machinery or an automobile production line, can have a digital twin created from it in order to digitally monitor, model, and simulate its behavior. Consequently, the physical asset's performance can be improved and asset owners can predict when it needs servicing.

The -- already strong -- trend toward such technologies has been enhanced by the COVID-19 pandemic. For example, the inability to keep production going during the lockdown periods has served to highlight the benefits of having automated production that's controlled using IoT.

All of PTC's solutions play to these themes.

How PTC makes money

The company's software solutions are divided into four groups, with CAD and product lifecycle management (PLM) defined as its core offerings, and the IoT and augmented reality (AR) solutions being its growth offerings.

The core offerings are PTC's legacy offerings, but you shouldn't think of them as low growth. PTC's CAD software (led by Creo) and PLM solutions (led by Windchill) have a growth opportunity as customers are increasingly shifting to using them as software-as-a-service (SaaS) options rather than on-premise software. In fact, PTC bought a SaaS product development platform, Onshape, in order to accelerate the trend. In addition, PTC's 3D CAD software helps engineers design products for 3D or additive printing. 

Thus, management sees PTC's core annual revenue growing in the high-single-digit to low-double-digit range over the medium term. 

An engineer working with CAD

ARK bought PTC stock for its CAD software solutions and exposure to 3D printing. Image source: Getty Images.

However, the really exciting growth potential lies in its IoT and AR solutions. PTC's IoT platform (ThingWorx) connects physical assets to the digital world -- the heart of the fourth industrial revolution -- and its AR solution (Vuforia) allows skilled technicians to service equipment without being physically present. Together, management sees them rising at a 30% plus annual growth rate over the medium term.

In case you are wondering, the focused solutions group (FSG) is a collection of software products targeted at specific industries. Annual run rate (ARR) is defined as the annual value of renewable customer contracts at the end of the reporting period.

Annual Run Rate 

2020

2019

Change

Management's Estimate for Growth Rate Over the Medium Term

Core

 $911 million

 $799 million

14%

High single-digit to low double digits

Growth

$181 million

$135 million

34.3%

30%+

FSG

$178 million

$183 million

(2.4%)

Low single digits

Total

 $1,270 million

 $1,116 million

13.8%

Midteens

Data source: PTC presentations.

Growth stock, growth stock valuation

Turning to valuation matters, PTC's management recently affirmed its medium-term targets for midteens ARR growth and free cash flow (FCF) in the range of $700 million to $900 million in 2024. Unfortunately, the COVID-19 pandemic means it's more likely that PTC hits something closer to the bottom end of the range.

Based on Wall Street analyst forecasts PTC will need to generate FCF growth in the 26%-62% range in 2024 in order to hit the $700 million to $900 million aim. Given the expected growth rate (see below) in 2022 and 2023 the $700 million, at the least, looks achievable. 

FCF is important because it represents the flow of yearly cash available to the company to make acquisitions, pay dividends, pay down debt, or make share buybacks. 

PTC Metric

2019

2020

2021Est

2022Est

2023Est

2024Est

Free cash flow

$221 million

$214 million

$345 million

$444 million

$555 million

$700 million to $900 million*

Growth

4%

(3%)

61%

29%

25%

26%-62%**

Data source: marketscreener.com. *PTC estimates. **author's analysis.

To put this figure into context, PTC's current market cap is $14.48 billion, meaning that $700 million in FCF in 2024 would put it on a price-to-FCF multiple of around 20 times FCF in 2024. That's a very attractive valuation for a company with midteens revenue growth.

Is PTC a buy?

In the end, it boils down to your level of belief in Industry 4.0, notably in  IoT and AR, ARK Invest's belief in PTC's exposure to 3D or additive printing.  Given the growth rates achieved in PTC's pandemic-hit fiscal 2020 and management's forecast of 9%-12% growth in ARR in 2021, it appears clear PTC is on track.

Moreover, if you think the economic recovery in 2021 will lead to a step up in adoption of Industry 4.0 technology, then there may well be upside to PTC's earnings estimates. On balance, despite a strong rise in the share price in 2020, PTC remains a very attractive stock for investors.