Why 1 Analyst Still Likes II-IV -- and IPG Photonics, Too

By Rich Smith Markets Fool.com

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

Continue Reading Below

Yesterday was a big day for investors in the burgeoning field of industrial lasers. Early in the morning, two of the biggest players in this industry, laser parts supplier II-VI (NASDAQ: IIVI) and fiber laser maker IPG Photonics (NASDAQ: IPGP), both announced earnings for their fiscal Q3 2017 and fiscal Q1 2017, respectively.

Both companies beat earnings, but investors' reactions to their news couldn't have been more different. Here's what you need to know.

For Needham & Co., the light's still flashing green for laser stocks. Image source: Getty Images.

1. II-VI reports

Let's get the bad news out of the way, and start off with II-VI. The laser parts supplier reported$0.35 per share in profit on $245 million in sales for its fiscal Q3 2017, beating analysts' profit estimates by $0.01, and coming in nearly $5 million ahead of revenue projections. That accomplished, however, II-VI proceeded to shoot itself in the foot by offering guidance for fiscal Q4 that seems to have disappointed investors.

Continue Reading Below

II-VI told investors that Q4, currently in progress, will probably see it earn between $0.33 and $0.37 in profits on sales of $245 million to $252 million. Taken at their midpoints, these two ranges suggest II-VI is preparing to report results that will fall somewhat short of consensus estimates for $0.36 per share in profits, and $250 million in sales. Not a huge shortfall, to be sure -- but try telling that to investors, who sold off II-VI shares by more than 16% yesterday.

2. IPG Photonics reports, too

The story at IPG Photonics was both similar and yet very different. Reporting $1.38 per share in profits last quarter, IPG easily surpassed analyst estimates of $1.34 per share. On the sales front, IPG reported sales of $286 million -- more than $32 million ahead of consensus targets.

On top of all that, IPG told investors that Q2 is looking better than expected, and raised its guidance for this quarter's profits to $1.60 per share, on sales of nearly $330 million. Investors' reaction: They bid up IPG Photonics stock by nearly 8%.

3. Needham makes its call

This morning, investment banker Needham & Co., which tracks both laser stocks closely, tried to parse these similar results, differing guidance, and wildly differing reactions by investors. As StreetInsider.com reports, while Needham is broadly in agreement with how investors reacted to IPG Photonics' news, it thinks investors' reaction to II-VI's results was a bit "overdone."

At II-VI, strong 35% Q3 growth in sales its optical communications business was offset somewhat by more muted 13% growth in the company's industrial lasers segment. And yet, II-VI also said that bookings (which can be predictive of future sales growth) were up 19% year over year for the company as a whole. But crucially, bookings of industrial laser parts grew 30%, while the optical business saw bookings up a more muted 6% -- the reverse of how sales ran in Q3.

In other words, while one half of II-VI's business ran faster than the other last quarter, the other half of the business is poised to outperform in the current quarter -- which one would think means things will even things out rather nicely for this fiscal second half. At the same time, strong performancedownstream in the laser industry at IPG Photonics suggests that the industry as a whole is still doing just fine. And one would think that this, too, bodes well for II-VI's own business going forward.

When all's said and done, therefore, Needham remains optimistic about both companies -- II-VI stock and IPG Photonics stock alike. Despite investors' differing reactions, Needham is maintaining its buy ratings on both II-VI and IPG. The only changes Needham is making: It's tweaking II-VI's target price slightly lower to $38 and upping its target price on IPG to $146 per share.

What comes next

That being said, at valuations of 23.4 times trailing earnings for II-VI and 25.4 times earnings for IPG, both stocks already seem to be priced pretty aggressively. Needham may very well be right that the laser market is healthy and IPG Photonics and II-VI will both benefit, but the price targets for both stocks -- which predict 37% growth in share price for II-VI, and 9% growth for IPG Photonics -- seem to be taking a lot of future profits for granted. If I were considering an investment in this sector, I think I'd prefer to wait for valuations to calm down a bit before buying either of these stocks.

Meanwhile, the third major player in the lasers sphere, Santa Clara, California-based Coherent-- which itself bought out another laser peer, Rofin-Sinar, last year -- reports earnings after close of trading on May 9. We'll make sure to look check out those numbers, too, in hopes of finding a better bargain there.

10 stocks we like better than II-VI
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and II-VI wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of May 1, 2017

Rich Smith has no position in any stocks mentioned. The Motley Fool owns shares of and recommends IPG Photonics. The Motley Fool recommends II-VI. The Motley Fool has a disclosure policy.