I can see why someone might want to sell losers at the end of the year to offset capital gains. Why would someone want to sell winners just because of the time of year? Maybe just because they have a lot of losers and to take advantage of?
I think they are being very careful not to overstate. Perhaps an attempt to keep reins on some of the exuberant analysts? They know that unanticipated costs (such as advertising) can happen.
At $63.50 where CREE shares were trading after hours, I expect a 9% annual return with a worst case 0.6% annual return and upside of 15% annually. Moreover, in these projections, I do not adjust for CREE's cash. CREE currently has $1 billion in cash or 11% of its market capitalization and well above what it needs to run its business. CREE will continue to generate significant cash over the next few years, which it could use to issue dividends or buy back a lot of stock. The company could easily buy back 3% of its shares annually through 2020 without impacting future growth, which would make future returns even higher than that which I projected based on business fundamentals alone. By returning cash to shareholders, CREE could be $210 by 2020.
Long-term investors can generate superior returns by purchasing stocks that are unfairly beaten up because of short-term disappointments that don't impact the long-term theme. This is the exact situation CREE finds itself in. The move towards LED lighting is here and undeniable. As the market leader, CREE has the potential for significant growth for over a decade as this shift matures. Investors should be happy management is investing in the long-run rather than trying to game quarterly EPS expectations, which often results in long-term weakness. The CREE story is intact with significant upside potential and minimal downside risk. I would use this pullback to initiate or add to a position.
That is why I was actually happy to see these quarterly numbers. I have been wanting to initiate a position in CREE for the past month after I did a deep dive on LED technology and growth prospects. This quarterly report, which did nothing to shake my long term conviction, provides investors who are focused on the long-run an excellent entry point. Frankly in my opinion, the quarter was not that bad at all. The company reported EPS of $0.39 (up 45% YoY) and revenue of $391 million (up 24% YoY), both of which were in line with estimates. At the same time, gross margins of 38.6% showed sequential and annual improvement, though they were a bit less than expected. Importantly, light bulb sales grew exceptionally fast, 37%, which suggests strong adoption of its product.
Now, some investors were disappointed with CREE's guidance. Its revenue midpoint of $410 million was marginally below the $414 million estimated while its EPS guidance was weak due to lower margins at $0.36-$0.41 vs. analyst expectation of $0.44. The biggest risk to CREE is depressed margins as competitors like Phillips and General Electric (GE) launch LED lights; however, CREE's lower margins in the next quarter will be the result of increased advertising of its light bulb. The only way CREE can gain share and grow revenue is by advertising. While this ad blitz will hurt near term results, they are essential for long-term growth. I prefer a management with a long-term plan. This quarter makes me no-less confident of future growth potential while providing a better entry point. I also believe margin concerns are overhyped. To grow share, it is important for LED prices to come down. After all, no one would buy a $100 light bulb! I expect end prices to trend a little lower, but so will input costs, and higher sales will increase utilization, increasing operating margins as fixed costs take up a lower share of revenue. With this in mind, I have updated my base, bear, and bull case, which shows significant upside for CREE:
Seeking Alpha Oct 23 2013, 03:32
Disclosure: I am long Cree.
Warren Buffett has built an unparalleled track record by investing in the long term while all but ignoring short term fluctuations. He finds companies in good position within a growing market that are poised to deliver strong results for many years down the road. The fact is that many of these companies from time to time report bad numbers because no management team is perfect, but if you let yourself get spooked out by one quarter, you would lose out on many years of appreciation. When a company reports a bad (or what is perceived to be bad) number, long term investors should ask whether these numbers are an aberration or a harbinger of things to come. In other words, is the long-term rationale for owning the stock undermined? If yes, you should sell. If not, you should ride out the volatility and perhaps add to your position at a very attractive price.
It is with this philosophy that I bought shares of Cree after hours. Upon reporting results, shares of CREE were slaughtered, and I bought some at $63.50 or 14% below where they closed. CREE makes energy efficient LED lights, which has been a tremendous growth segment within the $120 billion light industry. LED lighting is gaining popularity, but it still dwarfed by traditional lighting. CREE has made an LED light bulb that looks exactly like a regular one while maintaining its energy advantage. I believe this product will help CREE gain a foothold in the consumer lighting market, which is the majority of the total market. I expect that by 2020, LED lighting will dominate the market because they provide significant energy savings for consumers. Moreover as Asia continues to industrialize, lighting will grow relatively fast. I expect total LED sales to grow to 75% of what will be a $160 billion market, and CREE is perfectly positioned to profit from this growth.