3-D printing stocks: for brave investors only

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Additive manufacturing? Sounds boring. But 3-D printing? Now, that's sexy.

So sexy, in fact, that the companies in this emerging industry have been huge winners this year, with most seeing their shares double or more in 2013. The biggest players in the field hit record highs Monday.

Then came a big two-day selloff, prompted by a negative research report on Voxeljet AG, one of the smaller names in the industry. Although shares in the sector partially recovered over the course of Thursday and Friday, most are still a few dollars below their peaks.

That is what qualifies as a buying opportunity in the sector. Only the bravest investors, willing to risk losing much of their investment, should look past these stocks' volatility and remarkably rich valuations – the cheapest trades for "only" 50 to 60 times earnings. Those willing to stomach all that, however, might see opportunity in a trend that could transform how things are made.

"I've been trying to find a similar manufacturing technology that has had a similar evolution, and there probably isn't one," says John Baliotti, an analyst for Janney Capital Markets who was trained and worked as a mechanical engineer before going into securities analysis. "It's hard to find a parallel to what you're seeing."

Rather than slapping ink on paper to create a two-dimensional image, 3-D printers use liquid, powder or other material to fashion a three-dimensional object. While the basic technology has been around for three decades, early models were slow and expensive. Newer versions are getting faster and cheaper. While some 3-D printers sell for more than $1-million (U.S.), a few of the newest offerings go for $5,000 or less, and are even being labelled consumer models.

The cognoscenti prefer to call 3-D printing by its more technical name: additive manufacturing. The term is used to distinguish it from the traditional method of creating a part, which started with a piece of metal, then ground it or shaped it – subtracting whatever wasn't needed in the final product. In contrast, additive manufacturing "prints" an object by laying down layers of heated powder – usually aluminum, steel or plastic – on top of one another, adding volume as it goes. This allows for faster creation of prototypes and more easily customized parts.

"I visited the owner of a traditional manufacturing company which, in the last four years, has completely transformed itself with the purchase of 10 3-D printing machines," says Mr. Baliotti. "I talked to him about whether these [stocks] are expensive and whether the growth is sustainable. And his view is that [his company] isn't making these investments for what's going to happen in the next two to three years; they're planning for the next 20-plus years."

Mr. Baliotti concedes that stocks in the sector are no bargain if you look simply at 2014 forecasts. Still, he has "outperform" ratings on the three companies he covers, based on his optimism about their long-term prospects.

The two most established companies are 3D Systems Corp. (DDD-N) and Stratasys Ltd. (SSYS). Both of these U.S.-based firms have done a good job in selling the high-margin "consumable" material for their printers that is akin to the ink in conventional printers. But while conventional printing companies struggle with competition from generic ink and toner makers, 3D Systems and Stratasys have proprietary materials that work only with their printers.

Analysts like 3D Systems' product line, since it offers printers that can print in nylon, plastic, wax, rubber, metal, and composites materials. The team at Credit Suisse says the company has the highest profit margins in the industry and the most diversified offerings, which should position it well for growth.

For now, though, investors should brace for volatility. Credit Suisse started coverage of the company in September with an "outperform" rating and target price of $62, which 3D Systems blew right by. The shares approached $85 Monday, fell to $68.30 Wednesday, and closed Friday at $73.30 (U.S.).

Stratasys shares have been on a similar wild ride this year, climbing from around $81 in January to nearly $130 before falling this week. The company has broadened its product lineup and geographic reach with recent deals that Andrea James, an analyst with Dougherty & Co. LLC, labels "strategic home run acquisitions." (She has a "buy" rating and $139 target price, above Friday's $116.97 U.S. close.) One of the deals was for MakerBot, maker of a consumer 3-D printer that sells for $5,000 or less, compared to $10,000 to $600,000 for Stratasys's existing lineup.

3D Systems, too, has consumer offerings called Cube and CubeX. The wild card in predicting the future of the industry – and, hence, the valuation of these stocks – is figuring out if consumers will adopt these printers.

Analyst Daniel Holland of Morningstar has "fair value" assessments of the two companies well below current prices because he thinks "the market has overpriced the opportunity here."

Anyone can use an iPod or a VCR, but operating a 3-D printer demands expertise, he says. "You do actually have to know something about computers. If you can't draw in Microsoft Paint, it's going to be very interesting for you to try to figure out how to design a 3-D object."

He acknowledges that the companies have now introduced 3-D scanners, which allow users to scan objects for the printers to produce and remove the need for knowledge of computer-aided design software. Mr. Holland previously assumed 1.5 per cent of U.S. households would adopt the technology in the next 10 years; he now believes it will be closer to 5 per cent.

It's possible, however, that all the focus on the consumer question distracts from just how many sales these companies will make in the manufacturing sector. The report that sank the sector this week said that Voxeljet, a much smaller company than Stratasys or 3D Systems, had sold just three of its $500,000-plus printers in its most recent quarter.

However, few observers doubt that manufacturers are intrigued by the long-term potential of 3-D printing. The Credit Suisse analysts calculate that for the 3-D printer market to grow 20 per cent annually for the next three years, sales of the machines will need to reach $1.2-billion, or $500-million more than today. That "is insignificant in the context of what industrial firms globally spend each year on manufacturing equipment," they say, noting that manufacturers of aircraft engines alone are on track to spend $1.6-billion in 2016.

That's a huge opportunity, regardless of how many consumers ultimately find a use for the machines in their homes. And it suggests that even stocks with P/Es above 50 might ultimately print profits.