When it comes to technology, many companies that make the components of popular products wind up being much more profitable than firms that use them to make a finished product. That has especially been true over the last decade. That’s why I believe that fiber optic stocks could be the biggest beneficiaries of the spread of 5G.
For example, most smartphone makers other than Apple (NASDAQ:AAPL) and Samsung have made little or no money. But many makers of smartphone components, from Skyworks (NASDAQ:SWKS) to Qorvo (NASDAQ:QRVO) to Cirrus Logics (NASDAQ:CRUS) to Analog Devices (NASDAQ:ADI) have made huge profits. Similarly, datacenter operators and PC makers haven’t made that much money in the last decade, but many companies that make high-tech products used by datacenters and PCs — think Nvidia (NASDAQ:NVDA), AMD (NASDAQ:AMD) and Micron (NASDAQ:MU) — have done much better.
I think a similar scenario could play out in 5G. When it comes to 5G stocks to buy, most of the attention has been given to Nokia (NYSE:NOK) and Ericsson (NASDAQ:ERIC). Those companies are more or less like the Dell of 5G networks; they do supply some components, but much of their job consists of integrating components made by other vendors.
For investors, the real money may come from companies that make the high-tech components that will be used in 5G. One crucial element of 5G networks is fiber. As Wired put it last year:
5G will happen in the airy realm of radio waves. … There’s (a) crucial part underlying this system: lowly cable. Huge numbers of new transmitters will be needed to relay all that data to your phone, and many of those transmitters will still connect to the internet through fiber-optic cable.
Therefore, companies that make components related to fiber optics should do very well going forward. Moreover, unlike Nokia and Ericsson whose large market caps make them unlikely takeover targets, fiber optic component makers could easily be acquired. A number of these companies, including Oclaro, Finisar, and Acacia, have already been acquired in recent years.
Further, the three fiber optic component makers below are leveraged to multiple, extremely powerful tech trends, not just 5G.
5G Fiber Optic Stocks to Buy: Lumentum (LITE)
Lumentum (NASDAQ:LITE) markets “next-generation optical communications solutions” for 5G. For example, it provides optical transceivers, SDN optical elements and reconfigurable optical add/drop modules. An optical transceiver “is a device that uses fiber optical technology to send and receive data.” An SDN is a type of virtual switch or router, while “optical add/drop modules allow for intermediate locations to easily access the common fiber segment linking all the network nodes together.,” according to Transition Networks.
On Lumentum’s second-quarter results conference call held on Feb. 4, the company’s CEO, Alan Lowe, said its “growth was driven by strong demand for our differentiated coherent telecom transmission products and high-speed laser transmitter chips for datacenter and 5G Fronthaul applications.” And in a statement that bodes very well for Lumentum and the two other companies profiled in this column, he said, “demand over the long run should be strong based on the continued strong growth expected in global networks and datacenter traffic and the optical infrastructure needed to support 5G wireless bandwidth.”
As indicated above, Lumentum is leveraged not only to 5G, but also to datacenters, which are growing rapidly. Analysts, on average, expect the company’s earnings per share to climb nearly 25% this year. However, LITE stock is only trading at 15 times analysts’ average 2020 earnings per share estimate.
The company provides optical products that connect all of networks’ components to the networks’ cores. Ciena recently unveiled “new 5G-optimized routers” that can be used throughout 5G networks, according to FierceWireless.
In December, the company reported lower-than-expected Q4 earnings per share, but, according to Seeking Alpha contributor Stephen Simpson, “the miss was driven largely by higher compensation expenses tied to the better-than-expected performance for the full year.” Moreover, Ciena’s revenue rose 7.6% YOY and its EPS is expected to climb nearly 25% this year.
Despite its rapid expected EPS growth, CIEN stock is trading at just 13.75 times analysts’ average 2020 EPS estimate.
In addition to its 5G growth drivers, Ciena provides data center products to Amazon (NASDAQ:AMZN) and Facebook (NASDAQ:FB). Of course, both of those companies will launch a large number of new data centers in coming years — boosting Ciena’s results and CIEN stock in the process.
The company acquired another major optical component maker, Finisar, in 2018. According to Reuters, II-VI (NASDAQ:IIVI) “makes a range of transceivers to help transfer high-speed data traffic through undersea cables and 5G networks.”
Among the optical components made by II-VI are transceivers, monitoring devices and amplifiers. In addition to telecom functions, its optical products are used to facilitate subsea voice and data transmission and datacenter functions.
During II-VI’s fiscal Q2 earnings conference call, held on Feb. 10, its CEO, Chuck Mattera, reported that:
Our ramp of new products for 5G has accelerated as over 80 carriers rearchitect their networks to handle the transition from 3G and 4G as 5 billion mobile subscribers today begin to migrate to 5G. We believe that a large and multi-year opportunity for II-VI is unfolding.
Mattera added that the company’s datacenter business began to recover in Q2.
Two of the company’s other businesses — 3D sensing and silicon carbide — are also closely tied to powerful, rapidly growing tech trends. Specifically, 3D sensing is being incorporated into many smartphones and autonomous and semi-autonomous vehicles, while silicon carbide is used for electric cars. Mattera said the company’s revenue from 3D sensing and silicon carbide jumped more than 100% and 77%, respectively in Q2, versus Q1.
Analysts, on average, expect IIVI’s revenue to surge 63% in fiscal 2020 versus fiscal year 2019. As it spends money to integrate Finisar, its EPS is expected to tumble to $1.50 this year versus $2.54 last year. But in FY2021, its EPS is expected to soar to $2.89. The current forward P/E ratio of IIVI stock, based on its expected FY2021 EPS, is only 10.85.
Larry Ramer has conducted research and written articles on U.S. stocks for 13 years. He has been employed by The Fly and Israel’s largest business newspaper, Globes. Larry began writing columns for InvestorPlace in 2015. Among his highly successful, contrarian picks have been GE, solar stocks and Snap. You can reach him on StockTwits at @larryramer.