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Is Xaar plc a falling knife to catch after 15% share price fall?

Buying any stock that has fallen significantly in one day can be a risky move for an investor. In most cases, the decline in valuation is due to a profit warning or some other negative news which impacts on the future profitability of the business in some way. As such, it can be difficult to judge what the company in question is worth, as well as how its risk/reward ratio may have changed.

That’s the situation with digital inkjet technology developer Xaar (LSE: XAR). The company’s share price declined by over 15% on Monday after it released a profit warning. Could now be an opportunity to buy it for the long run? Or, is it a stock which is best avoided at the present time?

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Difficult period

The company is facing a more difficult second half of the year than it had anticipated. It had expected its sales to be weighted towards H2, with growth in revenues from new products due to increase. However, it now anticipates sales to be similar to the level in the first half of the year. This is due to fewer than planned new printer installs of Xaar’s 2001 Printhead, as well as a slower ramp up of the Xaar 1201 Printhead due to supply constraints.

In ceramics, the company’s printhead replacement business is now expected to represent around 70% of revenue in 2017. There has been strong demand for the new 1003 Printhead, but due to intense competition for new printer installs, there has been more limited success with the 2001 product.

Due to supply constraints, it has not been able to fulfil all of the demand for the 1201 Printhead. It expects to rectify this with new capacity which is due to come on stream in 2018. Following this, it expects to see significant growth from 2018 onwards.

Positive outlook?

Despite a difficult period for the business, it has been able to reduce its dependence on the legacy ceramics business. This could be good news for the company’s future since the ceramics business faces reduced visibility as competitive pressure increases. Furthermore, the company continues to invest in sales and marketing as it seeks to deliver on its transformation plans.

However, its near-term outlook appears to be difficult to judge. It seems to be facing multiple challenges at the same time as it is trying to change its business model. This could prove difficult at a time when many of its products are facing increasing levels of competition. This could mean further disappointment over the coming months.

Therefore, with the stock trading on a price-to-earnings (P/E) ratio of 17.4 using last year’s earnings figure, even after its 15% share price fall, its risk/reward ratio does not yet appear to be favourable. It may be prudent for investors to avoid the stock at the present time.

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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.