Growth stocks have come under intense selling pressure in the past few months. And a poster child for that carnage has been Cathie Wood's Ark Innovation ETF (ARKK 1.63%). The fund returned more than five times the S&P 500 index in the 12 months beginning in February 2020. Now, just one year later, almost all of the outperformance has disappeared. During the drop, the controversial investor has sold off some positions to double down on those in which she has the most conviction. 

One of the stocks she jettisoned was Proto Labs (PRLB 38.69%). It has continued falling in the months since. But now might be the perfect time to add it to a long-term portfolio. Here's why.

A person standing at their computer in a manufacturing environment.

Image source: Getty Images.

A year to forget

There is no doubt Proto Labs has been a lousy investment. That's especially true over the past year. As the Ark Innovation ETF was falling, the stock performed like a lead weight. It dropped fast and didn't let up. In the past year it is down 76%, compared with a 23% rise for the S&P 500 index. It isn't hard to see why a shareholder would be frustrated. It woefully underperformed even the low bar of the Ark ETF. 

PRLB Total Return Level Chart

PRLB Total Return Level data by YCharts

The stock price isn't the only thing falling

Wise investors often share the advice that equities can be extremely volatile with little regard for the underlying business. And a key to successful investing is to pay a lot more attention to the business than the stock price. Unfortunately for Proto Labs shareholders, that hasn't been a pretty picture either.

Despite revenues growing over the past few years, gross margin has been slipping. That means it costs more to bring each dollar in the door. Although the company has recently blamed labor inflation and supply chain constraints, those didn't exist until recently. Margins have been in a downtrend for some time as the company moved further into the 3D printing industry.  

PRLB Revenue (TTM) Chart

PRLB Revenue (TTM) data by YCharts

In the company's latest quarterly report, it attributed about 15% of sales to 3D printing. That's not much more than the 10% of organic sales it made up in the same quarter five years ago.  The problem is the 3D service itself.

3D manufacturing company 3D Systems (DDD 13.00%) illustrates this. Its gross margin actually turned negative in 2019 and has trended lower ever since. It might be a sign you're in the wrong business if you lose money with every sale even before expenses like sales and marketing or rent. To its credit, Proto Labs still makes money. Analysts expect $1.40 in earnings-per-share (EPS) for the 2021 fiscal year.

A silver lining

All of that paints a fairly grim picture for the company's prospects going forward. So why do I think it has a chance to be a winner in the long term? It's all about the customers. The number of unique developers using Proto Labs' digital manufacturing platform has grown steadily with the only interruption being the darkest days of the pandemic.

Period Unique Developers YoY Growth
Q3 2021 23,457 25%
Q3 2020 18,796 (13%)
Q3 2019 21,471 3%
Q3 2018 20,792 23%
Q3 2017 16,909 19%
Q3 2016 14,271 14%
Q3 2015 12,541 24%

Data source: Proto Labs. YoY=year-over-year.

Speed is a competitive advantage. And Proto Labs offers it. The faster developers can test new designs the faster they can put them into production. Those might achieve better performance, increased efficiency, or even a lower cost. Testing and iterating to find winning ideas is the heart of innovation. And it's simply the way business is done in the 21st century. 

Manufacturing isn't an industry where change happens quickly. And it's clear that investors in Proto Labs -- including Cathie Wood -- expected a lot of growth before the company could deliver. But the consistently increasing adoption of its services is a good indication that customers recognize the value. Eventually, Wall Street will too.