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Applied Optoelectronics Inc (AAOI) Stock Isn’t for Heroes

Bret Kenwell

Applied Optoelectronics Inc (NASDAQ:AAOI) has been one of the more volatile names on investor watch lists this year. AAOI stock is up 151% in 2017, but there have been a lot of bumps along the way.

Despite Dips, Applied Optoelectronics Inc (AAOI) Stock Isn't For Heroes

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After plunging from $98 to $65 on Aug. 4, most investors thought worst was over. But yesterday, the company hit them again. AAOI announced preliminary fiscal third-quarter earnings results well below Street expectations.

At the midpoint, non-GAAP earnings should come in between $1.04 per share to $1.09 per share. Prior guidance called for $1.30 per share to $1.43. Analysts were looking for earnings of $1.31 per share.

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Revenue will come in between $88 million to $89 million. Previously guidance expectations were for sales of $107 million to $115 million. Analysts were looking for $111.6 million. Margins were the only thing that didn’t suffer materially in the quarter. But to say this was a disappointing quarter is an understatement.

What Is Applied Optoelectronics?

Unlike Apple Inc (NASDAQ:AAPL) or Netflix, Inc. (NASDAQ:NFLX), Applied Opto isn’t a particularly familiar name.

In a nutshell, most of AAOI’s customers are data centers. So we’re talking about companies like Microsoft Corporation (NASDAQ:MSFT) and Amazon.com, Inc. (NASDAQ:AMZN). Roughly 85% of last quarter’s revenue came from data center sales, where AAOI makes the necessary equipment for these facilities to transfer data via fiber optic cables.

As Facebook Inc (NASDAQ:FB), Alibaba Group Holding Ltd (NYSE:BABA), AMZN, AAPL — you name ’em — continue to pile up as much data as they can, they need data centers. Especially when it comes to their customers and their habits, to store data and cloud information and access that information at nano speeds, they need AAOI. So perhaps this explanation is a bit long-winded, but now you know just what the heck Applied Opto does and why its business stands to benefit from the data juggernaut.

What Went Wrong at AAOI?

Many investors are feeling deflated and frustrated about the recent results. They feel management misled them last quarter and could’ve been more accurate with their projections. Management’s explanation? “Lower than expected sales to one of our large data center customers,” was to blame for the results.

Management went on to say:

“Although we are disappointed with these preliminary results, we continue to feel good about our leadership position in advanced optics and remain optimistic based on the customer traction we are seeing with our 100G products, especially our 100G CWDM transceivers.”

AAOI stock chart

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Sizing Up AAOI Stock

AAOI has a trailing price-to-earnings (P/E) ratio of 14.6 and a forward P/E ratio of 11. AAOI is now two quarters into its fiscal 2017 year in which analysts expect earnings per share of $5.32. This would represent almost 300% growth from 2016. However, in fiscal 2018, those estimates taper down to just 4.7% improvement.

 The question we need to ask now is, how long will the current issues persist? Obviously third-quarter results are shot and that will weigh on full-year numbers. But will fourth-quarter results need to come down too? How about fiscal 2018 — is that too optimistic as well? We don’t know those answers and that causes uncertainty. Uncertainty leads to selling and could cause even more losses.

Trading AAOI Stock

After powering through the $55 to $60 level in early May, this area had been support multiple times over the past six months. However, with the after-hours move on Thursday, AAOI stock looks prepped to gap down about 20% to $47.

I was surprised when I saw how big the short interest was — anywhere between 50% and 70% depending on what platform I looked at. Given its low valuation, improving financials and steep decline since August, I wouldn’t have been short AAOI stock. But that was the right play. Now shares are set to open in no man’s land. There may be support found near $45 and further support between $38 and $40.

But make no mistake: Don’t try to be a hero. At $47, there could still be significant downside, no matter how cheap the stock seems. The company will formally report Q3 results in early November. Wait for some support — be it $45, $40 or $38 — to prove itself, then enter with a reasonable risk/reward. Don’t buy and hope. Buy on proof.

Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell did not hold a position in any of the aforementioned securities.

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