In his book One Up on Wall Street, Peter Lynch makes an analogy between investing and betting on stud poker. It is a game where knowing how to manage your cards can make you a winner more often than not. You simply don't fold your cards if you have a hand that gives you favorable odds of winning -- assuming that you understand how to calculate the odds properly. In the case of Motley Fool Hidden Gems recommendation FARO Technologies (NASDAQ:FARO), another card was turned over in the form of fourth-quarter and fiscal 2004 results. Many investors looked and immediately folded.
The company, which makes state-of-the-art measuring tools, reported fourth-quarter sales of $28.5 million with earnings per diluted share of $0.35. Yearly sales and diluted EPS were $97.0 million and $1.06, respectively -- beating management's raised guidance of $0.95-$1.05. Yearly sales were up 35.1%, and earnings were up 79.5%. Earnings did include a $1.9 million -- or $0.13 per diluted share -- income tax benefit. Taking the tax benefits out would mean that raised estimates were not met and may be the reason for investor malaise.
On the flip side, management may be taking exception to today's price drop. CEO Simon Raab made it clear in today's conference call that the company is exerting significant effort on taking advantage of international operations to keep tax rates low. In management's view, success on the tax line is a success like any other essential component of the income statement, and it is directly related to operations. Furthermore, the company still has more than $5 million in deferred tax assets, $1 million of which may be realized in fiscal 2005.
Investors may also be taking exception to the broad range of 2005 earnings guidance, which is expected to be $1.03-$1.36 per diluted share. This guidance includes an estimated $2 million in expensing of stock options and $500,000 in continued costs for compliance with Sarbanes-Oxley. In addition, the lower end of earnings estimates would assume a less efficient performance in a number of balance sheet items in 2005 -- assuming sales of $121 million-$125 million. With management having a history of outperforming estimates -- especially initial estimates -- the lower end is probably a little too conservative.
Those with a long-term outlook on the company can point to a number of other positive things. The company's investment into expanding its sales force in the Asia/Pacific region has been a tremendous success. Similar investments being made in Korea and India should have an impact on sales and profit margins in 2005. And the strategic planning meeting the company is planning for next month will provide further insight into the company's five-year plan to build FARO into a multibillion-dollar company.
Still, the company looks to have another bumpy year in 2005, since sales and investments into infrastructure will most likely vary quarter-to-quarter and are hard for management to predict -- thus the reason for providing only yearly guidance.
Of course, we all know how much the market likes uncertainty. But if your long-term outlook hasn't changed, then this year could present several opportunities to buy at a discount. With a trailing P/E of 25 for a company expecting 25%-30% annual sales increases, one of those opportunities may be right now. Just make sure you keep recalculating your odds as each card is revealed.
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Fool contributor John Bluis owns shares of FARO Technologies. The Motley Fool is investors writing for investors .
