You don’t always get it right in the stock market. When it comes to fiber optic stock Applied Optoelectronics Inc (NASDAQ:AAOI), I was more than just not right. I was way wrong. AAOI stock tanked in a way I hadn’t imagined.
It has been a painful ride down for this once-surging supplier of cloud data centers. After a torrid run higher from mid-2016 to mid-2017 wherein the stock price increased by ten-fold, AAOI stock started dropping in July 2017 after its biggest data center customer, Amazon.com, Inc. (NASDAQ:AMZN), suddenly and dramatically lowered its spend on AAOI product.
It felt like this was a one-time thing. The rest of AAOI’s business was doing just fine. Product ramp outside of Amazon was proceeding as planned. Revenue growth (ex Amazon) was still strong, as was earnings growth. And AAOI stock was dirt cheap on a trailing basis, implying investors were pricing in an earnings fall-out.
So I thought the weakness in Applied Optoelectronic stock was a buying opportunity. I actually called the stock a steal below $50.
Applied Optoelectronic stock is under $35 today. Clearly, I wasn’t right. So what now?
I’m not entirely bearish on Applied Optoelectronics stock. I still think there is value here. But I’m not bullish on it, either. Recent reports of growing price competition and customer churn have me concerned about the future for AAOI.
Here’s a deeper look.
Why Applied Optoelectronic Stock May Have Found a Bottom
There are a few reasons why AAOI stock may have found a bottom.
First, the short curve is reversing trend. When Applied Optoelectronics was surging towards $100 from mid-2016 to mid-2017, short interest on the stock rose alongside the stock price. But short interest in Applied Optoelectronics stock didn’t soar until news broke that Amazon was dropping AAOI. After that news broke, roughly 75% of the float was short.
Short interest stayed high for a while, but it is finally coming down. Over the past three months, as AAOI stock price has sunk, the percent of the float short has fallen from 70% to 59%. While this may just be year-end profit-taking, it is still a sizable reduction showing that shorts have lost some conviction at these depressed levels.
Second, a member of AAOI’s board, Alan Moore, purchased $1 million worth of Applied Optoelectronic stock back in November. This is a notable purchase because Moore made a purchase of nearly identical value in AAOI stock back in June 2016, right before the stock took off from $10 to $100. This purchase is a big vote of confidence from a person who got it right before.
Third, Applied Optoelectronic stock is cheap. Dirt cheap. It trades at less than eight times this year’s projected earnings. If earnings can stabilize, this stock will head significantly higher in the long-term.
Why Applied Optoelectronic Stock May Keep Falling
There are also a few reasons why AAOI stock may keep falling.
To address the bull thesis, short interest is still unusually high considering how far the stock price has fallen. An insider purchase is more of a best-guess from an educated individual than a sure-fire sign the stock has bottomed. And the valuation isn’t cheap if earnings fall out over the next several years.
If that is true, that is really scary for AAOI stock. It means the Amazon customer churn problem isn’t isolated. And if that problem is spreading to Facebook, that is even worse news. AAOI has three main customers, and Facebook and Amazon are two of them.
There was also a bearish note from B Riley, which highlighted pricing competition as a margin compression risk. That seems to be a common concern for Applied Optoelectronic. It makes sense. As competition rises, supply will rise, prices will drop, and margins will erode.
Bottom Line on AAOI Stock
Right now, bear is beating bull.
Does that mean Applied Optoelectronic stock won’t ever rebound? No. This stock may have huge rebound potential if the Facebook churn rumors prove to be untrue and if Amazon comes back on board.
But those are big question marks, and Applied Optoelectronics stock is priced accordingly considering the future of the business remains bleak.
Consequently, I’m on the sidelines. I think it is best to wait for some clarity.
As of this writing, Luke Lango was long AMZN and FB.