Stock Shocks

We picked some shocking stocks to watch. And they've all done pretty well

May 25, 2006

8 Min Read
Stock Shocks

At the risk of being lambasted by the “how dare you talk stocks” crowd, I think it’s important to update the performance of our Leading Lights Best Investment finalists from 2005. Why? Because we picked 'em. And they've all done pretty well. (See LR Names Best Investment Finalists.)

Some background: The Best Investment Potential award was given out to the company that represents the best long-term potential return on investment by virtue of solid management, product development, and market growth potential. There were five finalists. These companies were picked on November 21, 2005, so the performance is from that date to the close of market last Friday.

There is an old Wall Street adage, "Sell in May and go away," reflecting the fact that the general market often performs best between November and April, and then goes into a summer slumber – or worse – from May to October. This year, apparently, many folks have taken that advice. With it being May and some serious volatility revisiting global stock markets in the past week – the stock market in India fell 10 percent in just one day – it’s a good time to take a look at these Light Reading stocks and talk about where they might go.

Here's how they've done:

ADVA Optical Networking

  • Nov. 21, 2005, price:€5.50
    May 19, 2006, price:€8.27

ADVA, also known as the “German Gem,” has performed like a Mercedes. And why not? It had all the attributes one likes: (1) Attractive market (metro optical and Ethernet); (2) Reasonable valuation (less than two times sales); and (3) Good earnings track record. (See ADVA Posts Q1, Optical's Future Looks Brighter, and ADVA's Still Shopping).

In fact, if I were to pick one stock that’s still an outstanding value, it’s ADVA. Because it’s traded in Germany, it receives a multiple substantially below its North American counterparts. Its recent acquisitions and new product launches in the metro Ethernet and optical markets are absolutely the right places to be. This is still an attractive stock.

JDSU (Nasdaq: JDSU; Toronto: JDU)

  • Nov. 21, 2005, price: $2.15
    May 19, 2006, price: $2.78
    Change: +33%

CEO Kevin Kennedy’s turnaround has progressed well and, as anticipated, the optical components space has continued to rationalize. Where do we go from here? Frankly, if we bought this one, we’d be content with a 33 percent gain in six months. But we don’t expect the stock to crash anytime soon. Many restructuring benefits are still likely to come.

If you didn't buy before the rally started last fall, this stock is probably too risky up here. With the market rally on the rocks, it's best to steer clear of single-digit midgets. We also noticed that JDSU recently issued some new debt. (See JDSU Issues Debt Notices).

It's safe to expect JDSU to chug along in the $2 to $4 range through the summer. In the fall, look for new visibility into the outlook for the second half of the year – and the market in general – each of which may provide a better window of opportunity. (See Whispers Shout Down JDSU, JDSU Buys a Bit of Test, JDSU Inches Toward Profits, and Notes From Needham .)

Motorola Inc. (NYSE: MOT)

  • Nov. 21, 2005, price: $23.75
    May 19, 2006, price: $21.42
    Change: -10%

Motorolewww, our only loser. No worries – it’s got a price/earnings ratio of 11. And $10 billion in cash. Even if the market crashes, this stock did not bubble like many other tech stocks, and its cash cushion provides downside protection.

We think Motorola’s Q device is going to be hot. (See Moto's Q Pulls Up to the Curb.) This seems like a silly stock to dump, if you are considering a loss. (See Motorola Makes WiMax Breakthrough , Verizon Moves Toward Home Gateway, and Moto Rides RAZR to Strong Q1.)

Neustar Inc. (NYSE: NSR)

  • Nov. 21, 2005, price:$31
    May 19, 2006, price:$33.26

Neustar, admittedly, has been a bit of a disappointment. The company's revenue growth has been subdued, even though it's solidly profitable. I still like the fact that it owns a government franchise in VOIP and ENUM databases. Management could do a little more to boost its visibility, but Neustar’s in a position to rule the future of VOIP databases. If the company can get its next-generation story together, this one could take off.

The bottom line: The trajectory of earnings and revenue has been up. There have been no serious hiccups, and we don't see any on the horizon. (See NeuStar Buys DNS Player, NeuStar Reports Q4, NeuStar Moves Into SIP Peering, and Telecom's New Star.)

Next Page

Redback Networks Inc.

  • Nov. 21, 2005, price:$12.75
    May 19, 2006, price:$23.00

Redback, quite simply, has been on a rampage. We're proud to say it won the Leading Light for best investment potential, and it has lived up to the award by posting the best performance of our finalists. (See LR Names 2005 Leading Lights Winners)

Why'd Redback go so green? It relates to three things: (1) Redback has hot new edge routing products geared specifically to the IPTV market; (2) It’s landing many new edge-routing deals, boosting sales, and stealing market share from Juniper; (3) It's a prime acquisition candidate.

Where's it all headed? If Juniper doesn't fix its IPTV and B-RAS story, well then, it could end up having to buy Redback. That is, if Alcatel, which owns a stake, even lets it.

The thing that makes us nervous about Redback is that it's the kind of stock that often moves up or down 5 percent on any given day. Redback isn’t cheap anymore, so it's definitely been profitable if you got in last fall. With a 1.2 billion market capitalization and a run rate of about $250 million, it's time to wait for a pullback if you are thinking of wading in.

There you have it – five stocks, four of which have done well.

What's next for the telecom market in general?

As stated at the outset, we are not expecting good things from the stock market from here until after October. The only question is: How much downside is there for telecom?

As I outlined in late 2004, I expected the telecom market to be powered primarily in one thing and one thing only: a return to growth in capital spending, with a possible acceleration in investment in access and fiber technologies. (See Telecom: The Next Generation.) Since then, the market has performed as if following the script. Capital spending has returned to a steady 10 percent to 15 percent annual growth rate. In fact, you could even argue that new initiatives such as IPTV and Fiber to the Whatever (FTTx) have exceeded expectations, and investment initiatives in these technologies could accelerate.

So what now? Global markets appear to be weakening, so a broader sell-off in stocks could pressure telecom service and equipment holdings. With some of these stocks showing profits of 20 percent and higher, there’s no reason to get greedy – take some profit if you have some. Yes, I am advising you to sell some in May and go away.

But I think there will be a time to come back, not in the next decade, but this year. The telecom market – and telecom equipment companies – should hold up better than the general markets, and here’s why: The market is rational. The telecom market crashed harder than any others back in 2000 and 2001. You don't usually see the same sector crash twice in a decade. Investors have been chastened. There are new sectors to crash, this time. There is not a lot of crazy money running around telco these days.

I also believe that the large telecom service providers are going to continue to invest in next-generation technology. They have no choice. They spent much of the earlier part of the decade cutting back and buckling down. In the past, telecom equipment spending has roughly followed a ten-year cycle. As we move closer to 2010, manufacturers are going to have to upgrade their plants, given that the last capital spending boom started tapering off in 2000. New services are being deployed, such as IPTV and wireless broadband, that will need a whole new range of equipment.

I think we've had some hints of this in the most recent sell-off. Stocks such as NeuStar and Redback were barely even dented. In fact, Redback has been up in recent days. Any weakness between now and the fall will be a buying opportunity. (See Video in Demand and Telecom Global Warming.)

— R. Scott Raynovich, Editor in Chief, Light Reading

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