Shares in Axon Enterprise (NASDAQ:AXON) are up 900% in the last five years. But whenever I think about buying the stock, I’m reminded of something Warren Buffett said.
The Berkshire Hathaway CEO knows the importance of growth. But the Oracle of Omaha also has a close eye on what matters most when it comes to investing in businesses.
An outstanding growth stock
It’s no accident Axon’s share price is up so much in the last five years. The company’s revenues have gone from $681m in 2020 to $2.3bn in the last 12 months.
Furthermore, the business has become fundamentally more attractive. It’s gone from being a hardware business (making police equipment) to having a significant software component.
Over time, that should be very positive for margins. And its strong market position within the law enforcement industry makes it very difficult for competitors to disrupt.
There’s a lot to like about the business – and these are the things that Warren Buffett typically values in an investment. But there’s something that puts me off buying the stock.
Investing 101
Something that Buffett said at the 2000 Berkshire Hathaway Annual Shareholder Meeting has always resonated with me. It’s about growth stocks and how much to pay for them:
“Let’s just take a company that has marvellous prospects, is paying you nothing now and you buy it at a valuation of about $500bn. Now if you feel that 10% is the appropriate rate of return – and you can pick the figure – that means that if it pays you nothing this year, but starts paying next year, it has to be able to pay you $55bn in perpetuity each year. But if it’s not going to pay until the third year, then it has to pay you $60.5bn in perpetuity to justify the present price.“
Of course, Buffett’s right – that’s just a matter of maths. But this basic point about valuation and investment returns goes some way towards explaining why I haven’t bought Axon shares.
Investment returns
Like all businesses, Axon’s ability to generate returns for its investors comes down to how much it makes. In 2024, the company’s free cash flow was $176m.
That’s not including the fact the firm had over $380m in stock-based compensation. In other words, the business didn’t make enough to buy back the shares it issued to employees.
Nonetheless, Axon currently has a market value of $66bn. That means a 10% annual return implies $6.6bn a year in perpetuity – but that seems unlikely any time soon.
The firm is going to have to grow sales at 30% a year for the next five years for its revenues to reach that level. But by that point, the required return in perpetuity will be $9.66bn.
Long-term investing
Buffett is a big believer in taking the long-term approach to investing. From this perspective, the question isn’t where Axon is now, but where it could be in 10 years.
While there’s nothing wrong with being patient,the eventual returns do have to justify the wait. And the longer that takes, the harder it is.
Buffett is dead right about this — and Axon is a long way from being able to offer investors a 10% return on its current market value. That’s why I find it hard to buy the stock.
