Cree (NASDAQ:CREE) makes electronics devices, getting most of its revenue from so-called light-emitting diodes (LEDs) and power chips. And, after reporting better-than-expected fiscal fourth quarter results, things are looking up. But should Cree stock be in your portfolio?

Cree’s sales and profits are shrinking, but not as much as had been expected – a development that boosted the stock 9% after-hours. One could argue that Cree did everything wrong: its earnings and sales fell while its expenses climbed. Specifically, its earnings were down 63%, revenues fell 8%, and expenses climbed 16% to almost $73 million.

But earnings per share and sales for the company were better than expected. Its adjusted earnings of 28 cents a share were 2 cents higher than expected by analysts polled by FactSet. And the company’s $243 million in revenues were 5% ahead of their expectations.

So should you buy Cree stock despite the declining financial performance? Here are two reasons to consider it:

• It’s cheap. Cree’s price to earnings to growth of 0.50 (where a PEG of 1.0 is considered fairly priced) means it is very inexpensive. It currently has a P/E of 20 and is expected to grow 40%, to $1.80, in 2013.
• Rising sales and profits, and a stronger balance sheet. Cree has been growing revenues and profits over a longer time frame. Its $867 million in revenues rose at a compound annual growth rate of 19.7% over the last five years while its net income of $205 million has increased at a compound annual growth rate of 16.3%, yielding a wide 24% net margin. It has no debt and its cash has risen at a 44% annual rate from $256 million (in 2006) to $1.1 billion (2010).

Two reasons to pause:

• Expectations-missing earnings reports. Cree has missed analysts’ expectations in two of the last five reporting periods, and did so by wide margins in those quarters.
• Cree is under-earning its cost of capital. Cree is earning less than its cost of capital – and it’s getting worse. How so? It produced negative “EVA momentum,” which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In fiscal 2011, Cree’s EVA momentum was -4%, based 2010 revenue of $867 million and EVA that fell from negative $103 million in 2010 to negative $138 million in 2011, using a 12% weighted average cost of capital.

Despite its wide margins and growing cash, this company needs to resume revenue growth and out-earn its costs of capital before it looks like a stock worth buying.

Peter Cohan has no financial interest in the securities mentioned.