In a few short years, what is taking over R&D labs across the globe will be ready for public consumption, and two companies are already building a bulkhead in this potentially huge sector, says Michael Murphy of New World Investor.

When I first started programming computers, they were mainframes sitting in special air-conditioned rooms with raised floors. If a user wanted something done—a new project, a small change to a report—they put in a request. In a few months, they might get what they wanted.

Then, in 1969 some folks in Palo Alto started Allen-Babcock Computing. They took a soldering iron to an IBM 360/67 and made it a timesharing machine, selling time for $10 an hour.

I signed up, bought a ten-characters-per-second terminal (a Datel, I think), and started doing quick turnaround projects for the investment department of American Express.

As soon as Tandy brought out the TRS-100 laptop, I bought one of those—still have it somewhere. And, of course, as soon as the Apple II came out I got one of those. Later, I bought an early IBM PC—$3,000 for the computer, $3,000 for a ten-megabyte Seagate hard drive.

I was only a little ahead of the whole world, as the personal computer completely changed the way almost everyone works and plays. Then came the Internet, and in 1987 I signed on with Portal Information Network, later to become Portal Software. It was the next great revolution in personal computing and communications.

Today, we have smartphones, tablets, streaming music and video, iTunes and its competitors, billions of Internet users, Facebook, Twitter…on and on and on. That first idea at Allen-Babcock of giving people direct access to computing power has morphed into the biggest MegaShift of all time.

And now I think I’ve found the next big thing. It is going to shake the foundations of mass production. It has the potential to make the US a manufacturing powerhouse again, when combined with robotics.

(When you have a robotic production line, there is no labor cost advantage to producing in low-wage countries. When you can produce custom products tailored to the customer’s exact wants at no extra expense, the advantages of mass production go away.)

To be clear, we are not there yet. But we are going there. I am referring to 3D printing of products, also known as additive manufacturing.

As the price of these printers falls, they are going to be in every R&D facility, then in every college, then in every high school, and eventually in every home. Like computers, people won’t remember how they got along without them. It is the 3D MegaShift.

Now imagine that as a sub-$500 printer that is extremely easy to set up and use, and you can see where we will be in about 2020 or 2025. Today, 3D printers are mainly used for rapid prototyping. Building a model of a new Nike shoe takes weeks and thousands of dollars by hand. With a 3D printer, it takes an hour and a half, and costs $50.

But while less than 20% of the output of 3D printers is actual final products today, the market research firm Wohlers says it will be over 50% by 2020. I think they are low.

This is an early-stage technology in the sense that there are many ways to do 3D printing. We’re about at the point where cars were powered by gasoline, steam, and electricity.

Some companies rely on nanotechnology, others on laser sintering, some like the above video on digital light processing of plastic powders, and some on other technologies. But they all work by depositing thin layer after thin layer of material in a series of passes to build an object from the ground up.

Instead of molding or using a specific cutting tool, the general-purpose printer can build objects of almost any shape and material strength. Like the general-purpose personal computer, it can do a wide variety of jobs and easily switch from one to the next.

It also doesn’t have to 3D print something until someone buys it. A manufacturer who invents a new gadget, or a jeweler, artist, or craftsman can create a design, print one to test it, and upload the computer code to a digital fabricator. The product is made after someone buys it. This is not just-in-time inventory control, it is just-in-time manufacturing.

When nearly every home has a 3D printer, a manufacturer can simply e-mail the code for a replacement part—no need to sit with a broken appliance until UPS gets there.

That’s the pie in the sky. Today, 3D printing was a $1.34 billion business in 2010, up 24% from 2009. It should hit $1.6 billion this year, and according to Wohlers, will hit $3.1 billion in 2016 and $5.2 billion in 2020. Again, I think they are way low on the 2020 forecast.

|pagebreak|

There are only two public companies of any size in the business today. Both are profitable. Both stocks have come down. I expect them to go lower in a major market sell-off, so I would use a multiple buy strategy to get positioned, starting with a one-third position in each.

3D Systems (DDD)
DDD has been building 3D printers for 25 years, and I’ve been following them almost that long—but never recommended them before.

They can print plastic, metal, or composites, and they have a broad range of printers from personal to production. They have a $900 million market capitalization, less than $8 million in debt, and over $79 million in cash.

In the June quarter, they reported $55.1 million in revenues, a 45.7% gross profit margin, and made 26 cents per share. They’ll earn about 77 cents a share in 2011 (December fiscal year) and 90 cents or more in 2012.

At today’s price around $16.50 they are selling for 18.3 times next year’s earnings, well under their projected five-year growth rate of 24%. They spend about $12 million a year on R&D, or 24 cents a share.

The stock has been locked in a lower highs/lower lows downtrend, although it may be about to break out. It suffered a “death cross” (blue arrow) in September, when the 50-day moving average fell under the 200-day moving average, but that is not an especially predictive pattern.

It is worth noting that 21% of the float is sold short, or a little over 12 days of trading volume. Someone thinks the stock is going lower.

They’ll hold their earnings conference call on October 27 at 11:30 a.m. The consensus expects $58 million in sales and 16 cents a share, in a pretty tight range. December quarter guidance should be $64 million in sales and 20 cents a share.

Given the very recent run-up in the stock and the level of short interest, I would buy a one-third position with a tight buy limit. DDD is a top buy for the next 12 months.

Stratasys (SSYS)
A smaller company, with a $497 million market cap, which reported $37.5 million in revenues in the June quarter. Their gross profit margin is better than 3D Systems at 52.5%, and they earned 18 cents per share in the quarter. They ended June with $18.5 million in cash and no debt.

They’ll earn 90 cents a share in the December 2011 year, and $1.10 or more in 2012. At today’s price of about $22.67, they are selling for 20.6 times next year’s earnings, a bit higher than 3D Systems, and about the same as their projected five-year growth rate. They spend about $15 million a year on R&D, or 69 cents a share.

SSYS also has been locked in a lower highs/lower lows downtrend, although it too may be about to break out. It suffered its “death cross” back in July, before a precipitous drop in August caused by disappointment over the speed of developing their Hewlett-Packard relationship.

Stratasys makes a line of HP-branded printers that are sold in several European countries. Although Hewlett-Packard has renewed the agreement, Wall Street wanted to see faster progress. Given the chaos at HP, culminating in the bizarre choice of Meg Whitman to be CEO, I’m not surprised that the relationship is slow to expand.

The shorts are here, too, with 16.7% of the float sold short, or a little over eight days of trading volume.

Stratasys will hold their earnings conference call on October 26 at 8:30 a.m. The consensus expects $38.2 million in sales and 21 cents a share, again in a pretty tight range. December quarter guidance should be $41.9 million in sales and 24 cents a share.

As with 3D Systems, given the very recent run-up in the stock and the level of short interest, I would buy a one-third position with a tight buy limit. SSYS also is a top buy for the next 12 months.

Subscribe to New World Investor here...

Related Reading:

A Biotech Buy Before Earnings
3 Small Caps Showing Leadership
Invest Like a Shark with These 3 Stocks