Rosetta Stone vs. SodaStream: Which Is a Better Investment?

Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

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 (NYSE: RST) or SodaStream International (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.

Rosetta Stone

An investment in Rosetta Stone 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'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 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.

SodaStream

Meanwhile, the SodaStream 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 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 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:

<img alt="" src="http://media.ycharts.com/charts/7fbf3bfea4a143ac0515488f8ada5806.png" />

SODA data by YCharts

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 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's Translate 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. 

By comparison, SodaStream has been solidly profitable for years and trades at a reasonable valuation compared to expected growth of 25% going forward. As a result of the company's track record of financial success, the primary risk is competition. For SodaStream, competition is far easier to assess than it is with Rosetta Stone; unfortunately for SodaStream, known competition comes from mega cap companies such as Coca-Cola (NYSE: KO) that already own a dominant position in the soft drink industry. While Coca-Cola hasn't offered any response to the potential disruption of the industry by home carbonation, it is certainly worth monitoring any developments regarding any future adaptation of the Coke Freestyle machine , which Coca-Cola spent $100 million developing, for the home. Coca-Cola and others have the ability to outspend SodaStream on research and development. SodaStream will also face competition from kitchen appliance makers.

While SodaStream is likely to experience competition on a number of fronts, it is important to note that the company has already taken steps to mitigate the impact. SodaStream deserves a lot of credit for seeking strategic partnerships to release well known flavors including Kool Aid, Country Time, and Ocean Spray as well as appliance partnerships with KitchenAid and Samsung. 

Evaluate which company is a better fit for the investment objectives of the individual investor

In addition to evaluating the merits and risks of each company, it is important to consider personal considerations. For example, a small portfolio of five stocks may not be well served by having both SODA and KO as holdings. There is nothing preventing both companies from continuing to outperform the market, but there is a clear overlap in terms of risk that will not help achieve the objectives of a diversified portfolio. Each investor also has a unique set of investment criteria, which may include factors such as a requirement of a certain track record of profitability. Accordingly, Rosetta Stone may not meet the criteria for consideration.

Make a decision based on the long-term view

A focus on the long term investment thesis of any addition to a personal portfolio is really the key to the decision process, whether it be between choosing Rosetta Stone, SodaStream, or any other publicly traded company. In this particular case, I continue to believe (and back with both a CAPScall and my personal investing dollars) that both companies will outperform the S&P 500 over the long-term.

Of the two however, SodaStream is the better long-term investment based on today's information. While the turnaround is underway at Rosetta Stone, the company is not profitable and revenue has been relatively flat for years as unprofitable business has been trimmed. In contrast, SodaStream is a company firing on all cylinders, and there does not appear to be anything stopping further market penetration thanks to geographic expansion, innovative new products, and strategic partnerships. This combination makes SodaStream one of my highest-conviction stock picks today, and the better of two very good investment options.

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Brian Shaw owns shares of Google, Coca-Cola, SodaStream, and Rosetta Stone. The Motley Fool recommends Coca-Cola, Google, Rosetta Stone, and SodaStream. The Motley Fool owns shares of Google, Rosetta Stone, and SodaStream. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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