We led off our Investment Comments in the January 2015 IAS issue by bluntly stating: “The last month has been eventful and unprofitable for investors.” The same can generally be said for all of 2015. Thanks to relatively poor returns in all asset classes, Bloomberg has dubbed 2015 “The Year Nothing Worked.” As of December 28th, the S&P 500 has gained just 2.1% year-to-date (all from dividends), while long-term bonds have lost 2.0%, cash has yielded 0.1%, and commodities have lost a whopping 23.4%. This isn’t normal. Since 1995, almost every year has seen some asset class deliver double-digit returns.
There are several headwinds that have held back all asset classes. For one, after seven years of zero interest-rate policy that boosted almost all asset prices, investors are now officially “fighting the Fed.” The Fed ended its quantitative easing program in October of 2014, and implemented its first rate hike on the path towards normalization this December. This comes at a time when global GDP and corporate earnings growth are both tepid at best. In response to weak growth, almost every foreign central bank is implementing monetary easing measures, putting added pressure on the already strong dollar, which continues to hold back the earnings of large multinational companies. Most concerning, however, is the collapse in commodities. Commodities have fallen to decade lows as tepid global inflation hampered precious metals, weakening Chinese demand crimped raw-materials prices, and a global supply glut sent crude oil plunging. As we noted in our Investment Comments last January, the plunge in crude oil is more damaging to commodity-centric emerging economies like Russia, which has been pulled deep into recession. While many of the over-levered players in the U.S. shale revolution may run into dire straits, we feel it is unlikely the collapse in the energy sector and emerging markets will pull the consumer-driven U.S. economy into recession.
But due to the myriad headwinds above, market volatility should remain high in 2016. We’ve always felt the best way to deal with the violent ups and downs of the market is to buy companies you’d be proud to own both in good times and bad. To us, that means buying growing companies whose futures are as bright as their pasts. To that end, we recommended the disruptive fiber laser maker IPG Photonics (NASDAQ: IPGP) in the January 2015 IAS issue.
IPGP’s CEO Valentin Gaponstev was one of the pioneers of fiber lasers in the early nineties. Compared with conventional lasers, fiber lasers offer more precision, better energy efficiency, and lower maintenance costs. As the diodes that power fiber lasers have become cheaper over time, IPGP has been able to sell its lasers at disruptive price points where the performance advantages make them the technology of choice for many industrial applications like metal cutting and welding. In our piece last January, we stated our investment case as follows:
“While fiber lasers are mainly displacing older laser technologies right now, they are also starting to win head-to-head against non-laser incumbent technologies, such as in torch-welding. Over time, fiber lasers should help the overall market for industrial lasers grow substantially. It’s hard to estimate a ceiling for this market, but we think it is very high and a long ways away.”
This bull case paid off handsomely in 2015, despite a market that was brutal on industrial companies. IPGP stock has gained 20.5% over the past year, compared to 1.5% for the S&P 500. It was a hard-earned 20.5% if you were an IPGP investor though, as you had to stomach substantial volatility. The company has significant exposure to both Russia and China, which have been the linchpins of the collapse in commodities and slowdown in global GDP growth. In 2014, IPGP derived 22% and 32% of its total sales from customers in Eastern Europe/CIS and China, respectively. As a result, time and time again the stock sold off significantly after news of instability or weak economic data coming out of Russia and China. And time and time again the stock came surging back when the company reported its quarterly results which stifled the market’s fears.
Every quarterly report in the past year has revealed unimpeded revenue and earnings growth that is nothing short of exceptional. Shortly after our recommendation in January’s IAS issue the company reported blowout 4Q14 results and strong guidance that sent the stock surging. Revenue grew 25% and EPS grew 53%, both handily ahead of analyst estimates and management’s own guidance. This fueled a nearly 40% surge in the stock price from $73 at the time of our recommendation to a quote north of $100. The stock rallied further to its 52-week high of $102.49 at the end of April when 1Q15 results revealed 26% core EPS growth on the back of 17% revenue growth. Top-line growth would have been closer to 25% again on a constant-currency basis.
The second quarter is when volatility really started to set in. Investors began to extrapolate the stock market volatility and economic slowdown in China onto IPGP’s business. Shares sold off to the $80 mark in late July. The correction was short-lived, however, as the stock soared back above $90 when the company reported 22% and 25% revenue and EPS growth in Q2. In constant-currency conditions, the top-line would have grown 35% and the bottom-line would have grown 36%. Sales to customers in China, the biggest source of investor fears, grew a whopping 42%. These results clearly confirmed to us that IPGP is a best-of-breed company in a disruptive growing market and shouldn’t be lumped in with the rest of the ailing industrial sector.
The market loves to repeat its mistakes, however, and when the Chinese stock market crashed and economic indicators worsened in late August, the stock started a tumble all the way back to the low $70s. But once again the company’s actual business results proved the doubters wrong. Revenue and EPS grew 22% and 12%, respectively, over an incredibly difficult comparison. Stripping out currency, revenue grew 34% and EPS grew 22%. To soothe investor concerns over the current global macroeconomic trends affecting IPGP’s customers, management also took the unusual step of proffering some preliminary 2016 guidance, calling for revenue growth of “at least 10%-15%.” The shares have since soared back to the $90 level, where they trade at a trailing P/E of 20. With over $10 per share in net cash, there is still much to love about this stock.