In 2013, 3D printing was touted by many investors as a revolutionary market that was going to transform the world. Its proponents called it a bigger revolution than even the internet, where commerce would be conducted on a higher level of abstraction. People would buy and sell blueprints, not products. We wouldn’t transport goods around the world—we would make them ourselves at home. The concept fit so well with so many science-fiction tropes, that the believers were hard to miss.
The stocks, as a result, performed as you would expect:
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With the charts moving up and to the right, the bulls seemed vindicated by New Year’s. Although VJET saw a huge correction around Thanksgiving, this was dismissed by some as a correction for one market share loser in a fast-growing market.
Then, in 2014, things began to change. First the stocks went down slowly, then their decline accelerated. The big gains from 2013 were almost completely gone by spring.
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How the Bulls Went Wrong
In growth investing, price targets are important and an exit strategy is essential, because growth stocks will almost always overshoot their mark and then correct. Growth investors can either try to identify and time those entry and exit points and invest accordingly, or they can bet against the trends for short-term gains. In either case, buy and hold will not work.
Yet the premise behind 3D printing investing was that buy and hold will work because this is a massive growth industry that will revolutionize the world. When investing in revolutions, it always pays to look a little deeper.
And this is what many 3D stock bulls did not do. Yet some simple questions could help them avoid the huge 2014 correction, if they were answered correct:
- What is the TAM of the 3D printing industry?
- What is the operating margin of these companies, and their projected sales growth?
- What sectors are they exposed to?
- How will macroeconomic trends (geopolitical stability, monetary base changes) impact the value of these stocks?
- What are the highest and lowest theoretical revenue and earnings these companies can be expected to earn in the next year, 3 years, and 5 years?
How Long/Short Profited
Long/short funds depend on identifying winners and losers in a sector to outperform, but they also depend on high-beta stocks. Beta is a simple statistical measure of risk, and stocks with a beta well over 1 will theoretically have a greater chance of declining in the future than stocks with a beta under 1. This is especially true if their EPS is low or negative, and their P/E is well above both market standards and sector norms.
This is a simple financial calculation that, for 3D stocks, was quite telling. All of these stocks had high betas, even during their bull run. The profitable ones had triple-digit P/Es (most weren’t profitable). The theoretical risk of these stocks was high, making them easy shorts.
However, timing that short would be difficult, because 2013 was such a bonanza for the market (and a great year for long-only funds). But an identification of high-beta stocks combined with a keen understanding of macro trends made 3D stocks a no-brainer short in early 2014, even as the fervor for the concept of 3D printing remained strong.
Of course, shorts cannot hold forever, and rebound stories are a favorite of distressed asset specialists. A long/short fund requires greater vigilance than long-only funds, so investors who are short these names and have seen declines of 50% or more will need to return to the questions 1-5 listed above. But those fund managers who understand the power of beta, and the folly of blindly betting on a revolution, have done much better than the raging bulls in this sector.