The optical-technology sector has seen sharp growth, with stocks such as Lumentum Holdings (LITE) , Fabrinet, NeoPhotonics and Oclaro delivering great returns this year.
The group's success is due to burgeoning Chinese demand and massive upgrades in data communications (10G/40G). Given this context and elevated earnings growth expectations this year, Lumentum is trading at an exorbitant price, exposing the stock to downside risk.
Are there better places to invest right now?
Lumentum's key areas of operation are optical and photonic products, empowering optical-networking and commercial-laser customers globally. Almost every piece of the massive telecommunications, enterprise and data center network pie is affected by Lumentum.
The stock's stupendous 65.44% year-to-date gain is a byproduct of its unstoppable growth. Lumentum's sales had a 5.5% compounded annual growth rate over the past four years, rising to $903 million in fiscal 2016.
Lumentum is expected to deliver a 15.5% revenue increase for fiscal 2017, almost three times the four-year average growth rate.
But the true picture lies in the valuation metrics.
The 13 analysts who have 12-month price forecasts on Lumentum have a median target of $37, suggesting that the stock will fall. The company is at a strong vantage point and is aggressively making in-roads into the data communication field, but sluggishness in the telecom segment looks likely.
Amid the buzz, Lumentum rival Infinera reports that slightly depressed demand is is the cards.
Infinera has been downgraded by B. Riley, JPMorgan Chase, Nomura and Raymond James.
The trend could ultimately extend to Lumentum.
Yet a slew of analysts have upgraded EPS expectations for Lumentum in the past 30 days.
Investors should watch for guidance and management commentary when Lumentum announces quarterly earnings. The slightest mention of a negative in the stock or a hint of cautiousness and investors may want to take profits, after what has been a great year.
In fact, booking profits isn't such a bad idea, if investors are ready to jump in wholeheartedly if a pullback occurs.