Vanity is always a good angle for a business looking to profit from basic human nature. Almost everyone wants to look better and most people want to do so without any pain involved. As a provider of cosmetic laser systems, Palomar Medical Technologies (NASDAQ:PMTI) offers virtually pain-free options for people looking for cosmetic treatments such as skin rejuvenation or the removal of hair or tattoos.
For the 11th straight quarter, Palomar achieved profitability, and sales in the fourth quarter were up 63%. While the company did not offer any cash flow information, a rough analysis of the balance sheet suggests it produced about $10 million or so in free cash flow for 2004.
In my past life as a Wall Street medical device analyst, there was always one sure way to get a portfolio manager to run screaming out of the room: mention a medical laser company. Historically, the medical laser market has suffered from numerous disappointments, failures, and outright frauds -- and making money through long-term ownership of these stocks was often impossible.
Palomar seems to be different, though. Not only is it profitable, but other extremely reputable entities have chosen to partner with it. In combination with Gillette (NYSE:G) -- soon to be owned by Procter & Gamble (NYSE:PG) -- Palomar is developing a home laser system for hair removal.
The company recently signed an agreement with Johnson & Johnson (NYSE:JNJ) to develop a home system for use in treating cellulite, acne, and skin aging. Palomar also has a relationship with the U.S. Army to develop a laser-based treatment for a skin condition called pseudofolliculitis barbae (in plain English, that's the razor bumps on the beards of men who have ingrown curly hair).
Palomar is clearly not the only company in the aesthetics space. Other companies like Candela (NASDAQ:CLZR), Lumenis (Pink Sheets: LUMEF), Syneron Medical (NASDAQ:ELOS), and Cutera all compete in overlapping markets.
While Palomar has recently settled patent litigation against Lumenis (and will be receiving royalties as a result), litigation is ongoing against Cutera. What's more, Candela has problems of its own lately. Thus, while Palomar isn't the only kid on the block, it's one of the better players in the market.
Palomar has many of the attributes that I like to see in small growth stocks. The target market is large and growing, insiders own a fair bit of stock, and margins and return on equity are both strong. Valuation, though, is another matter. This stock trades at nearly 41 times trailing earnings and more than 7 times trailing revenue. While I wouldn't bet against Palomar continuing to profit from people's desire to look better, I'll be waiting for the stock to look a little better itself, before jumping in myself.
Fool contributor Stephen Simpson, CFA, owns shares of Johnson & Johnson.
