Investors in LED-product maker Cree (NASDAQ:CREE) are used to volatility. But even so, the 14.5% drop in the stock price Wednesday following a disappointing earnings report must have left some with queasy stomachs.
 
However rattled they may be feeling after such a hard fall, many Cree supporters remain unshaken in their faith. LED’s, or light-emitting diodes, not only power television screens, smartphone displays, dashboard lights and market tickers, they are increasingly being used as a low-cost and more energy efficient alternative to incandescent
lights on outdoor streets as well as inside buildings and homes.
 
That long-term promise explains why Cree’s stock rose from a low of $13.89 in late 2008 to a high of $82.85 in the spring of last year. Since then, a sense of uncertainty has crept into the discussion of when Cree can achieve that promise. The stock has staggered in a volatile range between $50 and $80 since reaching that April high point.
 
Then came the earnings report for Cree’s fiscal second quarter, which ended Dec. 26, 2010. Revenue grew 29% to $257 million and earnings per share rose to 55 cents from 38 cents. As impressive as that sounds, it was well below what analysts were expecting: $277 million in revenue and a 58-cent-a-share profit.
 
When it came time for guidance, things looked even darker. Cree said it expects $254 million in revenue this quarter, well below the $265 million that the Street was expecting, and earnings per share between 38 cents and 45 cents. Again, the Street was hoping for a more ambitious 58 cents a share.
 
“Disrupting markets can be messy,” Cree CEO Charles Swoboda said in a conference call with investors. In this case, the disruption seems to be coming from China, where LEDs are being used more commonly in streetlights. China introduced new specifications for the streetlights, causing Cree’s customers to stock up inventories.
 
“They got ahead of themselves from an inventory standpoint,” Swoboda said. “So they’re going through an inventory correction.” The correction looks like it will extend into the current quarter, but isn’t likely to last into the summer.
 
Something similar happened with indoor LED bulbs. “Customers had bet that the market was going to go faster than it did, so they’re going through an inventory correction,” Swoboda said.
 
While Kaufman Brothers lowered its price target on Cree to $52 from $58, other analysts considered the problems facing Cree to be temporary. Yair Reiner of Oppenheimer wrote in a note, “The miss is a significant disappointment, but we believe it’s essentially a bump in the road … History also suggests that when it comes to inventory
corrections, it’s darkest before the dawn.”
 
Over at SeekingAlpha, some Cree bulls saw the 14% drop to be an opportunity for “a very nice gain to those willing to be brave while others run for cover.” Other analysts estimate that LEDs only make up about 5% of the lighting market, leaving a significant room for future growth.

Cree’s promise continues to shine in the distance. Just how distant isn’t certain, what is sure is that the stock is not one for the queasy.