This Promising Water Stock Has Big AI Aspirations

Technology stocks have been the focus of many investors, and rightfully so. Their performance over the past 15 years has been exemplary, crushing long-term market averages and outperforming other sectors of the stock market. Yet smart investors have begun to realize that the benefits of technological innovation will go not only to tech-oriented businesses but to the companies that use that innovation to further their own business aspirations.

Badger Meter (NYSE: BMI) is a great example of how this phenomenon is playing out. You could be forgiven for being unfamiliar with Badger and its legacy of water meters and measurement equipment. But if you're looking for less obvious ways to invest in companies that will benefit from AI and advanced automation technology, Badger's worth a closer look.

The first article in this series about Badger Meter focused on the history of this century-old business and the ways in which it has evolved over the years. Today, this article turns its attention to how Badger has turned its water management expertise into significant financial growth.

Image source: Getty Images.

Getting smart about water

Badger's strategy has centered on the need for water utilities and commercial users to take greater control of their water use. For utilities, older mechanical water meters lose accuracy over time, leading to lost revenue. In addition, newer meters are able to detect leaks and can handle tasks remotely that used to require physically traveling to customer locations, such as meter reading and service shutoffs.

Badger's new solutions include cellular radios that connect with monitoring software to provide stakeholders with much greater capabilities. In addition to savings from handling key tasks remotely, improved data informs analysis that encourages conservation and provides useful insights.

Badger is seeing growth accelerate

It's still early for the smart water movement, but Badger has already seen growth rates move higher in response to its upgraded technology. Since 2020, revenue has more than doubled. The company has generated average annual gains of 28% in recurring revenue from its subscription-based monitoring software platform. Badger specifically cites greater adoption of its smart water solutions for those favorable trends, both from cellular communications capabilities and from network monitoring for water quality and pressure.

Technological adoption has also been good for Badger's financial efficiency metrics. After the initial outlay of capital to create its network, Badger is able to bring on new customers at very little additional cost. This has reduced the amount of working capital the company needs to generate sales, and operating profit margins have jumped from under 15% in 2019 to nearly 20% over the past 12 months. Earnings have nearly tripled since 2019, and Badger is generating impressive amounts of free cash flow that it's using for a variety of purposes , including internal investment and strategic acquisitions. Shareholders have also gotten direct benefits from the surge in Badger's business, as dividends per share have doubled just since 2022.

Valuation concerns could be short-term in nature

Some forward-looking investors were early to recognize the impact that Badger Meter's shift in strategy could have on its financials. The company's share price more than tripled between mid-2022 and late 2024. The stock pushed further into all-time record territory before suffering a 30% pullback in the past six months.

Based on backward-looking numbers, concerns that Badger's stock might have gotten ahead of itself aren't without merit. Earnings multiples topped 40 before the recent pullback. Even now, the stock trades at valuation levels that are above its historical norms.

Yet there's a good argument that Badger still has enough future growth to justify the stock price at current level. In the third and final article on Badger tomorrow, you'll see more about how the company is fostering growth and why its management is more optimistic than ever about the prospects for smart water technology.

Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.