"Price is what you pay. Value is what you get." -- Warren Buffett.
Mr. Buffett wasn't specifically referring to TASER International (NASDAQ: TASR) when he said that. But it certainly would have fit. The reason for this is that while on the surface TASER stock appears quite expensive price at 66 times earnings, it's still a stock worth buying. Here why:
Why the pros are all "con" on TASER
But before I tell you why TASER stock is worth buying, let's consider the argument against the stock -- why 26.5% of TASER shares are currently sold short. Fortunately this is a question that's answered easily though: the price. Take a traditional value investor, for example, someone looking to buy a stock with a P/E ratio about equal to its projected long-term growth rate (for TASER, Yahoo! Finance says that growth rate is 30%). Based on this assumption you'd probably want to see TASER stock selling for half what it costs today -- $12 a share, rather than $24.
From a business perspective, you also have to wonder whether TASER can live up to its projected growth rate. After all, according to the U.S. Bureau of Justice Statistics, there were about 765,000 "sworn officers" in U.S. state and local police departments in 2008 (the most recent data available). Add 120,000 sworn federal officers and a few tens of thousands of military police, and total Taser-armable law enforcement personnel in the U.S. probably comes to around 900,000.
Against that market of potential buyers, the company recently confirmed that it had sold 700,000 Taser stun guns to law enforcement and military customers. Equipping all the rest of our police -- local, federal, and military -- with Tasers therefore looks like the work of just one more year of "30% growth." This suggests TASER's addressable market is just about saturated.
Lots of pros left for TASER
For one thing, even if TASER doesn't emphasize the point, you have to assume many of the 700,000 Tasers sold to date were replacements and upgrades for older models previously sold under TASER's "Assurance" warranty-and-upgrades program. There are still many officers out there in the U.S. who are not yet equipped with Tasers. And there are even more officers to whom Tasers can continue selling improved versions of its stun gun for years to come.
Also, the global market is far larger than 900,000 U.S. law enforcement professionals. True, TASER has historically done about 80% of its business here in the U.S. (according to data from S&P Capital IQ). But that still leaves a lot of untapped potential abroad.
And not just for "Tasers" per se. The company's burgeoning business selling on-body cameras -- and the storage space for the data they generate -- are further growth markets both inside the U.S. and abroad. CEO Rick Smith has publicly predicted that AXON cameras and TASER's EVIDENCE.com video evidence storage service "will become standard equipment [with police forces] within the next 5-10 years." And President Barack Obama's promise last year, to fund the purchase of 50,000 cameras with $263 million in federal funds, promises to accelerate that timetable.
Follow the money
Now let's come full circle to give you the kicker: valuation. On top of the strong business case for TASER having plenty of room to grow, the stock isn't even as expensive as it looks.
Sure, viewed from the perspective of generally accepted accounting principles accounting, TASER earned less than $20 million last year on $164.5 million in sales. But the company generated nearly $33 million in free cash flow on those sales -- 65% more cash profit than appeared on its income statement . (Free cash flow is operating cash flow minus capital expenditures). If you're only looking at this stock through the valuation lens of GAAP "accounting profits" -- P/E -- you could be missing TASER's significant cash-generating prowess.
What's more, after compounding at an impressive 20% rate already (over the past five years) TASER's profits appear set to grow by leaps and bounds. As already noted, analysts foresee 30% long-term earnings growth ahead, in part due to good publicity for the company's AXON on-body cameras, and in part because of the President directing taxpayer funds toward the purchase of these cameras. Meanwhile, TASER has already pushed through a 50% increase (from $10 per camera, per month, to $15) in the subscription cost to store data generated by all the videos these cameras are recording, and introduced higher price tiers to boot -- some of which result in annual data storage costs higher than the initial price of the camera.
Valued on its cash profits, I get a 39 price-to-free cash flow ratio for TASER stock. That's not "cheap" by any means. However, keeping in mind the company's 30% projected growth rate, TASER stock is a whole lot cheap-er than it looks.