Don't Tase Me Bro! Axon Stock Forecast With Insights From Insider Activity

Axon Enterprise Inc., the maker of Tasers, is all the rage these days. After all, there are few companies whose flagship product doubles as a verb in the lexicon.  AXON has an exciting new line-up of non-lethal electric weapons (which AXON calls Conducted Energy Devices) at a time of heightened sensitivity about police violence using firearms. Can AXON save the world from deadly police brutality?  And what are the implications for shareholders, with AXON’s earnings announcement date just a couple of weeks off?  We will take a look.  

Axon Enterprise Background

AXON investors could certainly be concerned about such a move from the majority of its ethics panel, as comments from Professor Abd-Almageed, a member of the panel, explained how attempts to discuss such plans with top management were not fruitful, saying “[w]e pled with [management] to pull back or at least wait until we had some serious discussions with them, but they didn’t listen to us.” AXON’s stock price did not move significantly on this news.

AXON recently announced its latest line up of weapons, leading with TASER 7 and TASER10. The TASER 7 carries four probes and can deliver 2,000 volts per pulse. The TASER 10 carries 10 probes and it can deliver a less-deadly 1,000 volts per pulse.  Additional probes can deliver additional volts.  The TASER 10 is also accurate up to 45 ft, about double the range of prior models.  Analysts are highly excited about AXON’s latest products, especially in the light of recent, highly publicized police events.  

Axon Stock Price History and Outlook

Axon Enterprise’s stock has been on a tear and it is up about 70% over the past six months.  Over the past five years, the stock is up about 700%, as shown below.  Hence, AXON’s stock price performance has been nothing short of miraculous.  It seems like AXON’s Tasers print piles of money in addition to delivering massive electric shocks.

What is the current outlook for AXON?  For starters, It is rated as a “Strong Buy” by Zack’s.  CNN Business reports that of the 13 analysts, 9 recommend buy, one outperform and 3 hold.  There are no sell recommendations.  Given this picture, is there a limit to how high AXON can reach?  

We decided to take a deeper dive to see what to make of this great performance.  First, we will look at the historical ratios as a part of our fundamental analysis.  Later, we will examine insider trading activity and managerial compensation to see how these fit into the larger picture.

Axon Enterprise Fundamental Analysis

For our fundamental analysis, we start with historical ratio analysis shown below.  As can be seen, AXON has enjoyed solid and steady annual sales growth of 20%+ over the past five years.  Cost of goods sold has also been low and steady at around 37%, giving it a gross profit margin of over 62% in 2021.  The problem areas for AXON are in R&D and SGA.  Its R&D has increased from 16.1% in 2017  to 22.5% in 2021, while its SGA has increased from 36% in 2018 to 59.3% in 2021.  These three items add up to 119%, giving AXON a negative net margin of 19%.  Hence, from the shareholders’ perspective, AXON has some work to do.

Other income statement items look mostly fine.  Depreciation has been trending down, there is no interest expense, and non operating income is trending up a bit.  As mentioned before, AXON has been able to increase sales by about 20% on a consistent basis.  Moreover, sales growth is still on an upward trajectory, rising from 22% in 2018 to 27%-28% in the last two years.  Profitability on the other hand has been choppy. In 2018, profitability increased 460%, while in 2020 and 2021 AXON experienced negative earnings.

Margin Analysis

The margin analysis below shows that the main advantage of AXON is to enjoy a rock solid, gross margin not less than 57% over the past five years.  This gives the impression of potentially gushing profits in the future as the business grows and fixed costs are eventually brought under control.  

Even though margins are very solid, the historicals showing SGA at 59% (2021) is, however, completely out of control.  Interestingly enough, the market does not seem to mind this too much at this time, given the steady growth of sales.  At some point however, investors will probably say, “show me some of the money, too.”

Forecasted Cash Flows

Let’s start our valuation analysis by forecasting future cash flows.  We will discount these cash flows at a very leniently low rate of 10%.  For our other valuation assumptions, we are again fairly optimistic.  We assume that high sales growth rates will be maintained with only a gradual decline over time.  We also assume that the cost of goods sold stays constant at about 37%, R&D is brought under control declining from 22% to 16% (best or lowest ratio over the past five years), and most importantly, and SGA brought under control from 59% to 36% (again the best or lowest ratio over the past five years).  In spite of these optimistic assumptions, we can only muster a per share fair value of $31 (shown below) against a market price of $197.  

Our optimistic fundamental analysis scenario suggests that AXON is overvalued by a whopping 500%. This is quite surprising given the stellar performance of the stock over the past five years and analysts’ excited outlook regarding AXON’s new line-up of weapons and loyal customer base. 

Before we dig deeper, let’s pause for a second and ask what would happen under a business-as-usual scenario.  Our analysis is shown below.  We find that if current financial conditions continue, AXON’s stock price would absolutely be crushed.  Our estimate of the fair value of AXON stock under recent financial performance conditions is -$79.

You might now ask what kinds of improvements in fundamentals would justify the current market price of $197?  Our analysis is shown below.  Using sales growth of 20%, R&D of 10% of sales and SGA of 10% of sales, the estimated fair value of $164.88 still does not come close to $197, leaving AXON overpriced by more than 20%.  Investors must expect sales growth to accelerate to over 35% and stay there for the foreseeable future.  Put another way, to justify the current stock price, investors must be expecting AXON to discover a gigantic mountain of gold at the recent price of $197.

Next, we address this large discrepancy between the current market price and the price derived from our free cash flows analysis.

Analysis of Executive Compensation at AXON 

So what could be causing this huge gulf between the fundamental analysis and the highly excited market view on AXON?  Why is AXON selling at $197 when a lenient fundamental valuation falls around $30?  For this question, we turn to the latest 10-Q dated September 30, 2022, and look for details of executive compensation.

First, in the latest 10-Q report, AXON states:  “On May 24, 2018, our stockholders approved the Board of Directors’ grant of 6,365,856 stock option awards to Patrick W. Smith, our CEO (the “CEO Performance Award”)”  At a recent price of $180 per share, the 2018 multi-year plan is worth well over $1 billion.  AXON does not skimp on managerial compensation, to say the least.

Second, AXON states:  “To supplement our financial results presented in accordance with GAAP, we present the non-GAAP financial measures of EBITDA and Adjusted EBITDA (CEO Performance Award).”  Hence, management compensation is based on non-GAAP Adjusted EBITDA and not on GAAP EBITDA.  

What exactly is Adjusted EBITDA, you might ask?  Adjusted EBITDA simply excludes management non-cash stock compensation:  “Adjusted EBITDA (CEO Performance Award) (Most comparable GAAP Measure: Net income) - Earnings before interest expense, investment interest income, taxes, depreciation, amortization and non-cash stock-based compensation expense.”  This is very convenient.  AXON can award any amount of managerial compensation without reducing Adjusted EBITDA at all. 

Hence, by focusing on Adjusted EBITDA, AXON management can report large positive non-GAAP earnings while free cash flows available to shareholders is negative.  For instance, in 2021, AXON reported a loss of $92M GAAP EBITDA and a profit of $170M non-GAAP Adjusted EBITDA, by excluding $262M in management compensation (for nine months ending in September 2021). Restating, in the first 9 months of 2021, managerial compensation amounted to 285% of the GAAP EBITDA.  Thus, by simply varying the amount of the compensation taken in any one year, AXON can calibrate its Adjusted EBITDA and thus the perception of AXON stock.  

Next, let’s take a look at the trading activity from AXON top insiders to see what they think about the valuation at AXON. If top insiders believe the stock is overpriced, they may engage in increased selling. If they believe the stock is properly priced, they may prefer to buy or do nothing.

Axon Enterprises Insider Trading

We’ll now look at trading activity by Axon top insider, founder and CEO Rick Smith. Mr. Smith’s trading activity is captured by the graph below, which shows AXON’s stock price (in red) over the last two years against sales from Mr. Smith (shown as the brown bars).  As the stock price peaked around $180 last time about two years ago, Mr. Smith started large-scale selling. 

(This chart is created using InsiderSentiment.com. Subscribers to InsiderSentiment.com can easily recreate this chart for any public company and subset of insiders at that company. With this view, you can see if the insiders in your portfolio companies have a similar strong timing ability, and use this knowledge to manage risk going forward.) 

From the graph, you can see how Mr. Smith exhibited a strong timing ability in sales that occurred at the end of 2021. From October 2021 through the end of the year, Mr. Smith sold over 1.1 million shares, worth over $180 million in total value. The last of the shares in this group were sold literally the day before the stock price started falling, before it would eventually bottom out at under $85 in June 2022. Further, Mr. Smith engaged in virtually no selling following these trades until very recently, even as the company’s stock price retraced its path upward throughout the second half of 2022.

As of the time of this writing, Mr. Smith has resumed selling, having sold approximately 750,000 shares in the second half of January 2023, just as the stock price returned to values similar to late 2021 highs and is now pushing $200 per share. While it is too soon to see if Mr. Smith will be just as prescient in selling this time as he was at the end of 2021, we will be watching eagerly to see how the stock price reacts.

Our Takeaway

The message from timely insider trading, combined with the fundamental analysis and market pricing is interesting.  There is no doubt that AXON is a money machine.  It has a highly successful set of products, highly loyal customer base, and exciting new opportunities both in the US and internationally.  It seems that the sky's the limit for AXON.

What matters for investors is not just that AXON makes a lot of money, but also who gets the money. If most of the profits earned goes to executive compensation, then long-term shareholders will not be happy.  For short-term traders, however, AXON presents golden trading opportunities. We expect the next two to three years to be relatively lean, and insider activity suggests this lean period could begin even sooner.  

For long-term shareholders, the message is that unfortunately, there is no pot of gold at the end of the rainbow.  Growing sales or huge gross margins is not likely to control a strong management team, especially one that causes the majority of the ethics board to resign.  The way things are going for AXON, there might be Conducted Energy going through the wallets of the long-term shareholders who are considering buying at these prices.