Proto Labs’s 34.3% return over the past six months has outpaced the S&P 500 by 21.5%, and its stock price has climbed to $42.81 per share. This was partly thanks to its solid quarterly results, and the run-up might have investors contemplating their next move.

Despite the momentum, we're cautious about Proto Labs. Here are three reasons why we avoid PRLB and a stock we'd rather own.

Why Do We Think Proto Labs Will Underperform?

Pioneering the concept of online quoting and manufacturing for custom prototypes and low-volume production parts, Proto Labs (NYSE:PRLB) offers injection molding, 3D printing, and sheet metal fabrication for manufacturers in various industries.

1. Long-Term Revenue Growth Disappoints

A company’s long-term sales performance can indicate its overall quality. Any business can put up a good quarter or two, but many enduring ones grow for years. Over the last five years, Proto Labs grew its sales at a sluggish 1.9% compounded annual growth rate. This was below our standards.

2. EPS Trending Down

We track the long-term change in earnings per share (EPS) because it highlights whether a company’s growth is profitable.

Sadly for Proto Labs, its EPS declined by 10% annually over the last five years while its revenue grew by 1.9%. This tells us the company became less profitable on a per-share basis as it expanded.

3. New Investments Fail to Bear Fruit as ROIC Declines

A company’s ROIC, or return on invested capital, shows how much operating profit it makes compared to the money it has raised (debt and equity).

We typically prefer to invest in companies with high returns because it means they have viable business models, but the trend in a company’s ROIC is often what surprises the market and moves the stock price. Over the last few years, Proto Labs’s ROIC has decreased significantly. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.

Final Judgment

Proto Labs doesn’t pass our quality test. With its shares topping the market in recent months, the stock trades at 31.7× forward price-to-earnings (or $42.81 per share). This multiple tells us a lot of good news is priced in - you can find better investment opportunities elsewhere. Let us point you toward TransDigm, a dominant Aerospace business that has perfected its M&A strategy.

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