Why Lumentum Holdings Stock Dropped 10% Today

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What happened

President Donald Trump doesn't like Chinese telecom equipment giant Huawei -- like, he really doesn't like it. And that could be bad news for U.S. companies that depend on Huawei to shore up their revenue streams.

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On Wednesday, the Commerce Department added Huawei Technologies and 70 affiliated companies to its Entity List, which effectively requires U.S. companies wishing to sell components to Huawei to obtain specific U.S. government approval whenever they want to make such sales.

Today, the stock of optical components manufacturer Lumentum Holdings (NASDAQ: LITE) is down 10.3% as of 3:15 p.m. EDT.

So what

So why is bad news for Huawei also bad news for Lumentum? According to investment banker Benchmark, Huawei accounts for about 15% of the sales Lumentum makes in a year.

Now what

Adding Huawei to the Entity List does not amount to an outright ban on Lumentum selling products to the Chinese company. But it holds the potential to turn into a ban, and at the very least, it makes continuing to do business with this key customer a bit more complicated for Lumentum. (It also may tar the company with a bit of a social stigma for doing business with a company that's become persona non grata).

Is all of this news bad enough to justify subtracting 10% from Lumentum's share price? Maybe, maybe not. But much of Lumentum's current valuation of more than 28 times free cash flow (and nearly 170 times trailing earnings) is tied up with expectations that the company will grow fast enough to justify such multiples. So anything that threatens to slow that growth has to be considered a risk to the stock.

Today's share price action suggests investors think this risk is very real.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.