When looking to make an investment, investors are often presented with making a difficult choice between multiple investment candidates. This decision is often further complicated when the candidates operate in completely different industries or have other significant differences (size, growth prospects, risks, etc.). For example, a reader recently asked the question of whether Rosetta Stone Inc (NYSE:RST) or Sodastream International Ltd (NASDAQ:SODA) is a better long-term investment; this is a fantastic question that definitely does not have a simple answer. Here's a look at one way to approach comparing the two companies.
Start with the investment thesis
Rosetta Stone and SodaStream are both small cap companies with big opportunities. However, that's where the similarities end.
An investment in Rosetta Stone Inc (NYSE:RST) is largely based on forward-looking opportunity. Language learning is a growing necessity in a world that is increasingly brought together by technology and the ongoing development of economies around the world. Global businesses and personal travel are two big reasons that people are likely to want to learn a new language (or refresh skills learned in school). This demand is on the rise, particularly in countries where disposable income is making higher education and travel within reach for more people. The current marketplace for products that address language learning needs is highly fragmented, which creates further opportunity from gains in share of the existing market. Additionally, there is significant room for technological disruption in education (both language learning and beyond), which presents the opportunity for a company like Rosetta Stone to position itself as a supplement, a component, or even a replacement of existing curriculums. To add to this multi-faceted opportunity, there are no formidable competitors standing in the way of Rosetta Stone Inc (NYSE:RST)'s efforts to seize these growth opportunities; most competing software solutions are not as polished or comprehensive, and the companies developing them are significantly smaller than Rosetta Stone.
Rosetta Stone Inc (NYSE:RST) is also in the midst of a turnaround. While new management has made steady progress in its turnaround efforts over the past year and a half, the investment thesis has to include a solid belief that the turnaround will continue as CEO Steve Swad has outlined repeatedly to investors towards a goal of "plus $400 million in revenue" and "a low double-digit operating margin" by 2015.
Meanwhile, the Sodastream International Ltd (NASDAQ:SODA) growth story is much easier to understand. Rather than imagining future product releases and international growth, SodaStream is actively disrupting the well-established carbonated beverage industry. While initially dismissed by many as a fad, Sodastream International Ltd (NASDAQ:SODA) has proven its disruptive capability through impressive growth rates that include year-over-year increases in consumables (syrups and gas refills) in excess of 100% in the United States. There is no better evidence that the company's products are gaining traction. Add in plans for continued geographic expansion and strategic partnerships such as the most recent partnership announcement with Whirpool's KitchenAid, and there is little reason to doubt management's target of reaching $1 billion in revenue by 2016. Considering that the worldwide soft drink market is expected to hit $310 billion in 2015, $1 billion could just be the tip of the iceberg for SodaStream.
Understand the risks
An investment in Rosetta Stone is inherently more risky than one in SodaStream given that Rosetta Stone Inc (NYSE:RST) has not been consistently profitable for a couple of years. The result has been a stock price that has dramatically underperformed the market over the past couple of years:
A failure to reverse this trend and resume profitability by 2015 is a huge risk to Rosetta Stone investors. Thus far, shares of Rosetta Stone Inc (NYSE:RST) have roughly doubled in value since Swad took the helm a year and a half ago; while this is certainly encouraging, there is a long way to go. The second major risk is the potential emergence of competition from a larger player in the software industry; thus far there have been no announcements to this effect, but a language-learning component built into a premium version of a platform such as Google Inc (NASDAQ:GOOG)'sTranslate could be a game changer. Third, there are lingering questions regarding Rosetta Stone's ability to execute its international growth strategy; recent struggles in Korea and Japan in particular have provided some doubt regarding Rosetta Stone's ability to capture the enormous international opportunity.