Is iRobot Stock a Buy Right Now?

Markets Motley Fool

iRobot (NASDAQ: IRBT) investors have had an eventful summer. iRobot's stock rose 21% immediately following a second-quarter earnings report that absolutely crushed expectations, but has since given up about half those gains. With the stock approaching pre-earnings levels, and high expectations for growth ahead, let's look at the pros and cons to determine if iRobot is a buy right now.

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The bull case: An adored product selling like hotcakes

Robotic floor cleaners are all the rage, and why wouldn't they be? After all, would any of us rather clean a floor ourselves rather than have a robot do it for us? These automated robots can adjust to different floor types, dock and recharge themselves, and allow scheduling so they can clean your house when you are not even home. Not only that, their navigation systems are adaptable, so they can adjust as things in your home are changed or moved.

iRobot, maker of the Roomba line, is the clear leader in robotic floor cleaners -- and it is not close. iRobot commands an 88% share of the market for robotic vacuum cleaners in North America and a 64% market share across the world. That is impressive. What is even more impressive is the fact that the company has held onto its dominant position over the past five years, even as new competition has entered the fray. In the United States and in much of the world, when people think of robotic floor cleaners, they think of Roomba.

The robotic vacuum-cleaner market has been growing by leaps and bounds lately. Specifically, the number of vacuum cleaners that are robotic has increased by 61% in the past four years. Management feels that growth is poised to continue for some time. At a recent investor conference, management stated that the immediately addressable market for robotic vacuums is two to three times the currently installed base and that 700% market growth is expected over the long term.

The company has been capitalizing on that addressable market, too. This past quarter, iRobot checked in with year-over-year increases in revenue and earnings growth of 23% and 64%, respectively. In addition, management increased its full-year guidance by 20%, and the company performed the impressive feat of expanding margins while significantly growing revenues.

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Finally, management has shown itself to be both innovative and adaptable. While all companies will claim to be innovative, iRobot seems to take it to the next level. iRobot has the 5th largest electronics patent portfolio in the world and the company is committed to continuous innovation at all price points. Management showed its willingness to adapt a year and a half ago when it divested its military unit and became a 100% consumer focused company. 

The bear case: Valuation, competition, and diminishing returns

Valuation serves as the first caution flag. Even after the pullback, iRobot stock carries a price-to-earnings ratio of 50 and a forward P/E of 37. Those are certainly high numbers; bulls would say that potential growth more than makes up for the current valuation. A closer look, however, may tell a different story.

Analysts expect 18% earnings growth over the next five years. If we assume they are accurate, and we apply a more modest price-to-earnings ratio in 2022 -- a P/E of 23 is a fairly conservative estimate -- then iRobot would have a stock price of $116.23, a very modest upside from today's price.

In addition, it is quite possible that iRobot's competitive moat may not be as large as we perceive it to be. iRobot definitely has a couple of things its competitors do not have. It has an impressive patent portfolio as well as widespread name recognition. However, these advantages could be short lived. Barriers to entry seem low.  Even with iRobot's patent portfolio, many companies, even small ones like Neato Robotics, ILIFE, and Ecovacs are already making comparable products and getting impressive customer reviews. As these smaller companies and their products start getting more name recognition, consumers might not "default" to the name Roomba when buying a robotic cleaner. At that point, it is quite possible that iRobot will either have to lower prices or risk losing market share.

With competition on the rise and home robot makers trying to grow their products into mass market adoption, iRobot is likely to amp up its R&D spending. While that is normal, it is also tricky, as iRobot must be careful to avoid falling prey to the law of marginal utility. In layman's terms, this means that over time, every dollar spent may bring a little less profit. This can happen if competition heats up to the point that each competitor starts to overspend in the name of innovation. Adding new bells and whistles is only good if the cost justifies the incremental profit. Home floor cleaners are pretty good already, so there's no guarantee that the next several years of upgrades will justify the cost.    

A Foolish final take

iRobot has beaten estimates four quarters in a row, and analysts are calling for impressive growth ahead. While I do think iRobot's impressive momentum will continue for the next year or two, I think low barriers to entry will allow new competitors to join the fray and current competitors to close the gap. I would also expect increased competition to bring both price points and margins down. New products could be the wild card, and if something like a nifty robotic lawn mower takes off, I could be proven wrong.

In the end, I think most of the future growth is already baked into the stock price. While I like the product lineup and I like the company, when it comes to buying the stock, I'll take a pass.

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Jeff Vande Hey has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends iRobot. The Motley Fool has a disclosure policy.