Pssst ... want a great stock tip?

Whether the tips come from your broker, buddy, or brother-in-law, it pays to do research before plunking down your hard-earned cash. With that in mind, this is the first in a series of articles that will walk you through my approach to evaluating a potential stock investment -- in this case, Sierra Wireless (NASDAQ:SWIR).

A presentation on the investor relations section of the company website appears promising. It says Sierra Wireless is a mobile-to-mobile (M2M) company "building the Internet of Things with intelligent wireless solutions." The presentation adds that ABI Research expects the number of devices connected to the Internet of Things (IoT) to grow from 1.4 billion in 2012 to 12 billion in 2020 (an annualized growth rate of 31%) and that Cisco estimates the M2M segment of the market will be $14.4 trillion in 2023. Moreover, Sierra Wireless is the M2M market leader with a 35% share and blue chip customers and partners.

Stunning growth makes the stock appear cheap
In the most recent quarter, non-GAAP results included revenue growth of 24% year-over-year and a whopping 12.3 times year-over-year increase in earnings from operations. Non-GAAP earnings per share of $0.63 in 2014 was up 91%, and analysts are forecasting additional 75% growth in 2015.

Despite these impressive financials, the stock trades at just 23 times forward earnings estimates. With a market cap of about $825 million, Sierra Wireless may fly below the radar of most institutional investors. A quick check shows institutions hold only 27% of the stock, suggesting there are a lot of potential buyers with fat wallets who could drive up the shares.

Sierra Wireless looks like an attractively priced, largely undiscovered way to ride the Next Big Thing. Hooray, this could be our lucky day!

Caveat emptor
Right? Go for it based solely on the investor presentation if you like. But keep in mind this is management's plan and vision. Some companies are good at meeting and even exceeding expectations. Others ... well, not so much. I would not lay down my hard-earned cash based only on management's pitch for the company.

So what is the next step? According to legendary investor Peter Lynch, the criteria for finding potential winners -- and avoiding potential losers -- vary by type of stock. So, I categorize stocks using the six types laid out in his book, Beating the Street. Here are brief descriptions:

  • Fast Grower: These have historical earnings-per-share growth of more than 20%
  • Moderate Grower: These have historical earnings-per-share growth of 10% to 20%
  • Slow Grower: These have historical earnings-per-share growth of less than 10% and usually pay a good, regular dividend
  • Asset Play: These own an asset that is not reflected in the stock price, such as real estate or tax-loss carryforwards
  • Cyclical: Revenue and earnings per share cycle up and down, typically with the economy and/or their industry
  • Turnaround: Earnings have declined, typically for reasons that are company or industry specific

What kind of stock is it, really?
Sierra Wireless appears to be a Fast Grower ... until we take a closer look at the company's historical revenue growth.

Swir

SWIR data by YCharts

The good news: Revenue has been growing at a nice pace since 2013. The bad news: It took several years after the Great Recession for Sierra Wireless to end hefty revenue declines, meaning it did not cycle with the economy. That knocks Sierra Wireless out of the Grower and Cyclical categories, so that leaves the possibilities of an Asset Play or Turnaround.

Asset play or turnaround?
In terms of Asset Plays, the 2014 annual report divulges $11,000 (not million) in Canadian tax-loss carryforwards, $9,000 in U.S. tax-loss carryforwards, and $6,000 in California R&D tax credits. These tax-loss carryforwards are losses from prior years that companies keep on the books to reduce tax obligations in the future. But the annual report also reveals losses from continuing operations in each of the last three calendar years, and in 2014, year-over-year revenue declines in the Americas (down 1%) and EAFE (down 22%). The most recent quarterly financials show a $10 million loss from continuing operations.

Swir

SWIR data by YCharts

The tax-loss carryforwards have been reducing taxes. That could be a small asset for some time ... when the company generates profits. But the vast divergence between earnings from continuing operations and non-GAAP earnings -- aka "earnings before bad stuff" -- is a big red flag. That and the disappointing revenue and earnings history overwhelm the tax-loss carryforwards, in my humble opinion. Therefore, I am going to classify Sierra Wireless as a Turnaround.

In the next article, we will focus on considerations that are relevant for turnarounds and Sierra Wireless in particular.

Cindy Johnson has no position in any stocks mentioned. The Motley Fool recommends Sierra Wireless. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.