iRobot Corporation (NASDAQ:IRBT) reported first-quarter earnings after the bell on Tuesday. And the numbers from the leading consumer robotics company were much better than expected.

Revenues topped expectations. This was largely expected as the revenue growth narrative hasn’t slowed at all recently. But earnings also came in much, much higher than expectations. This wasn’t as expected as the revenue beat. Last quarter, IRBT gave a down guide for earnings this year based on significant investments into marketing and product development.

Expenses did rise in the quarter. But so did revenues. And gross margins. Robust revenue growth plus a healthy gross margin lift more than offset rising expenses, and earnings came in head-and-heels above expectations.

Better yet, management raised its full-year earnings guide based on the better than expected first quarter performance.

IRBT stock opened Wednesday up 4.7% from Tuesday’s close. But as of this writing is now down 1.6% from pre-earnings prices.

Why? I can’t really explain it. It’s a head-scratcher. It seems investors are worried about competition, namely from Amazon.com, Inc. (NASDAQ:AMZN).

But such concerns are largely theoretical and highly overblown. As such, this looks like a great time to buy a misunderstood and dramatically undervalued growth stock.

Here’s a deeper look:

Q1 Numbers Were Strong

IRBT’s first quarter numbers were very strong, and actually much better than even most bulls expected.

Revenue growth in the quarter was 29%. That is essentially the same revenue growth IRBT reported in the year ago quarter, so the growth narrative of consumers adopting robots in their homes isn’t slowing at all.

This growth is also broad-based. Domestic revenues were up 26%. International revenues were up 32%, led by Europe, Middle East and Africa (up 47%) and Japan (up 38%). Clearly, this is not only a robust growth story, but a global one, too.

Meanwhile, gross margins healthily expanded 150 basis points to 53.3%. That is a testament to the company’s strong product in a crowded consumer robotics marketplace. Gross margins were supposed to erode due to that competition. Instead, they keep tracking higher because IRBT offers the best product in the marketplace, and consumers are willing to pay top dollar for it.

Operating margins did compress by roughly 110 basis points due to rising operating expenses. But these expenses are near-term in nature and should yield long-term benefits. They are going towards increased marketing (which should increase rate of mass-market adoption) and new products (which should expand the company’s addressable market).

Overall, the quarter was quite good. Revenue growth remained robust. Gross margins stayed on their upward path. And, despite operating margin compression, operating profits still rose by nearly 20% year-over-year.

IRBT’s Long-Term Growth Narrative In Tact

The strong Q1 numbers underscore IRBT’s even stronger long term growth trajectory.

IRBT is attacking a massive market. There are roughly 125 million households in the United States. Of those 125 million, only 10% have a robotic vacuum cleaner. That is up from 9% a year ago, and 8% two years ago.

Given Q1’s strong numbers, it looks like the percentage of households who have a robotic vacuum cleaner this year will shoot towards 11% and up.

In other words, adoption of consumer robotics is following a consistently upward trend which implies mainstream adoption in a relatively short amount of time. Given the enhanced convenience that consumer robots offer, I think it is likely that the adoption rate of consumer robots in the U.S. swells to 25% and up within the next 5 years.

And that is just on the domestic side. On the international front, the consumer robotics penetration rate is in the 2-3% range. It, too, is steadily climbing, also implying mainstream adoption in a few years.

 

All together, this is a big growth story that is still in its early innings. While some investors are concerned about competition (Amazon is reportedly jumping into the robot game), IRBT has historically been able to consistently push aside competitive threats and track higher on revenues and gross margins. This should persist.

iRobot Stock Is Materially Undervalued

By my numbers, iRobot stock is worth at least $77 today, and likely even more.

A 20% revenue growth rate is likely here to stay. At worst, revenue growth is in between 15% and 20% over the next 5 years. At the midpoint, that implies revenues of nearly $2 billion in 5 years.

Gross margins are inflecting higher into 50% and up territory. At worse, competition erodes some of IRBT’s pricing power, and gross margins fall flat at 50%. The operating expense rate is currently swelling, but historically, IRBT has been able to operate at a 37-38% opex rate. At 38%, 50% gross margins would flow into 12% operating margins.

A 12% operating margin on nearly $2 billion in revenues implies operating profits of nearly $240 million in 5 years. Taking out 26% for taxes and dividing by a presumably higher share count of 30 million, that equates to earnings per share of roughly $5.90 in 5 years. A market-average growth multiple of 19-times forward earnings on those $5.90 earnings implies a four-year forward price target of over $112. Discounted back by 10% per year, that equates to a fair value of roughly $77.

Bottom Line on IRBT Stock

Strong Q1 numbers affirm that IRBT stock is worth at least $77. At $58 and change, then, the valuation on IRBT looks compelling.

As of this writing, Luke Lango was long IRBT and AMZN.