Every month, I do my level best to help the world invest better by publicly calling out the company that I'll be buying to add to my Roth IRA. I've been doing this for almost two years, and my picks have returned a total of almost 23%, beating the S&P 500 by just under 3 percentage points.
Last week, I introduced five companies I was considering as my stock pick for the month: Nuverra Environmental, Apple , IPG Photonics (NASDAQ: IPGP ) , Dangdang, and SodaStream . Today, I'm going to tell you about the company I'm picking, the reasons why, and offer access to a special free report at the end of the article.
June's winner is...
As soon as trading rules allow, I'll be adding shares of laser maker IPG Photonics to my Roth IRA. To review the basic argument I laid out in my previous article: IPG's shares took a hit after earnings were announced in early May. The reason was that margins were compressed and Wall Street was worried about the company's long-term profitability.
But after listening to the conference call, it became clear that this margin compression was a conscious decision to forgo short-term profitability for long-term market share. IPG offered its lasers to customers at discounted rates in order to drive adoption. I believe that once buyers see how the company's fiber-optic lasers are superior to the carbon-based variety that dominate most industries now, they'll become lifelong customers of IPG -- willing to pay full price for all their future purchases.
What's so special about these lasers?
Source: IPG Photonics.
If you aren't familiar with lasers, the carbon-based variety has been the industry standard for years. IPG was a first mover in developing fiber-optic lasers. Although at first fiber-optic lasers were more expensive and less powerful, technological progress has changed the situation considerably.
In fact, the progression of fiber-optic lasers follows a well-documented path for many disruptive innovators.
Source: Author, based on The Innovator's Dilemma by Clayton Christensen.
Here, the blue line represents carbon-based lasers, while fiber-optic lasers are the red line. We likely just passed the inflection point now where red is beating blue.
Right now, 88% of IPG's sales come from the materials processing industry -- which focuses on cutting and welding large pieces of metal. The rest is made up by the advanced applications, communications, and medical industries.
The latter three make up interesting growth opportunity for IPG. Because the company claims that its lasers are more powerful, energy efficient, reliable, and cheaper than what the rest of the industry has to offer, IPG could easily diversify its customer base over the coming decade.
Speaking of the rest of the industry...
Of course, just because IPG was the first major company to design fiber-optic lasers doesn't mean it's impervious to competition. There are four other major players in the fray, but none has the focus and scope that IPG offers. Specifically, IPG focuses on fiber-optic lasers exclusively, and is vertically integrated -- meaning that all parts are made and assembled in house -- which helps bring the price of IPG's lasers down.
Rofin-Sinar (NASDAQ: RSTI ) , Coherent (NASDAQ: COHR ) , Newport (NASDAQ: NEWP ) , and JDS Uniphase (NASDAQ: JDSU ) all offer fiber-optic lasers as well.
When it comes to JDS, its important to realize that the company's focus is far broader than IPG's, focusing primarily on communications solutions. Although that covers an area where IPG competes, communications accounted for just 4% of IPG's sales in 2012.
That leaves Rofin, Coherent, and Newport as the primary competition. But a huge weakness each of these companies have is that they also count heavily on carbon-based lasers for a bulk of their revenue. That means that the company's attention is split, and that in order to develop fiber lasers, they will have to cannibalize their traditional carbon-based offerings.
In 2012, Rofin-Sinar noted that revenues were down significantly for carbon lasers, while the only segment producing positive trends were fiber optics.
Coherent recently reported that revenue for its material processing fiber-optic lasers jumped 16% from the previous year. That's not bad, but it's nowhere near the 29% increase IPG experienced in the same sector over the same time frame.
And Newport announced that net sales actually dropped during the first quarter of 2013 by 16%, which caused earnings to plummet almost 60%!
Clearly, though I'm sure the lasers these companies offer are fine, they aren't as advanced as IPG's, and the corporate structure doesn't allow for such focused marketing and development of the new wave of lasers.
How to proceed
As I said, when trading rules allow, I'll be buying about $450 worth of IPG stock, as that's 1/12th the allowance for a Roth IRA. I think today's price-to-earnings ratio of about 20 underestimates the long-term possibilites for this leading disruptive innovator.
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