It all began with a hot stock tip. My goal with this article series was to walk you step-by-step through my process for evaluating a company and its stock -- in this case, using Sierra Wireless (NASDAQ:SWIR) as an example. Having covered everything from the turnaround strategy to its recent financial performance and valuation, this final installment will look at the ultimate question for an investor: to own or not to own?
With that in mind, legendary investor Peter Lynch advises investors to have succinct answers to these questions:
- Why could this stock be a moneymaker?
- What needs to happen for the company to succeed?
- What are the pitfalls?
- Why is it a good buy now?
Let's approach these one at a time.
Why could this stock be a moneymaker?
Management has focused Sierra Wireless on the Internet of Things market. Forecasts for this sector call for rapid growth -- the number of devices connected to the IoT will surge from 1.4 billion in 2012 to 12 billion in 2020, an annualized growth rate of 31%, according to ABI Research.
Cisco estimates the machine-to-machine, or M2M, segment of the market will be $14.4 trillion in 2023, and Sierra Wireless is the market leader in M2M connections.
What needs to happen for the company to succeed?
To succeed, the IoT market will need to see that rapid growth as hoped. However, Gartner doesn't expect mainstream adoption of the IoT for another five to nine years. In the meantime, Sierra will need to fend off deep-pocketed competitors during the shakeout phase of the technology lifecycle.
Most recently, results have been mixed since the company shifted to its pure-play IoT strategy. Revenue growth exceeded 20% in late 2014 and early 2015 but is expected to slow to 15% for 2015 and 13% for 2016. That leaves the company dependent on acquisitions to fuel growth.
To fund those frequent buyouts, the company generated just $18.7 million in free cash flow over the last four quarters with another $96 million in cash and equivalents, although much of that is needed to run day-to-day operations. And based on the company's recent spending spree, it won't last long -- in the past year and a half, the company has spent over $130 million on four deals.
What are the pitfalls?
One major cause for concern: The company is underinvesting in research and development, which could dampen future growth. Even though revenue grew 17% year-over-year during the last quarter, SG&A grew only 9%, and R&D fell 10%.
Further, none of the recent additions to Sierra Wireless' senior management team appears capable of improving the company's underwhelming track record. The company's return on equity (a measure of management effectiveness with shareholder capital) has been negative frequently during the past 10 years, including the past few quarters. Operating cash flow hasn't grown with revenue, raising concerns that the company will need to issue additional shares and/or debt to fund its acquisitions. Either could act as a drag on earnings growth.
Why is it a good buy now?
The stock does not look like a good buy at this time, even though shares sit at about half of their 52-week high.
Without any of the challenges I mentioned above, the stock still appears pricey, trading at 21 times adjusted earnings. Its PEG ratio -- a method of ballparking price-to-earnings against future growth -- is similarly in very unattractive territory at 3.5.
What could drive the stock up in the near term? A positive earnings surprise or major developments in the IoT sector, but that rationale for buying a stock resembles speculating more than investing.
There are better uses for your hard-earned cash right now than Sierra Wireless stock. Uncertainty around its acquisitions, operations, and the IoT in general make up a hefty list of challenges to overcome in the next few years. At its current valuation, anyone owning the stock is counting on the entrenched management team to turn over a new leaf, and this "whisper stock" has much to prove to shareholders.