Why Optical Networking Stocks Surged in May

What happened

Shares of leading optical networking specialists rose sharply in May 2018. According to data from S&P Global Market Intelligence, these three market leaders enjoyed exceptional 31-day returns:



Stock Gains in May 2018

CAPS Score (Out of 5)

NeoPhotonics (NYSE: NPTN)

Optoelectronic components and networking modules


5 stars

Lumentum Holdings (NASDAQ: LITE)

One-stop optical networking shop, plus commercial lasers


5 stars

IPG Photonics (NASDAQ: IPGP)

Fiber lasers and laser systems


5 stars

Data sources: YCharts.com and Motley Fool CAPS.

So what

While there were some unique wrinkles in each stock’s chart and story, they generally rose as a group on news with industrywide implications.

The global market for high-speed networking tools has been lagging in recent quarters for a few important reasons.

First, the final standards for 5G wireless networking are being hammered out, leading many telecoms and related companies to sharpen their 5G plans and push “pause” on 4G equipment orders. Since wireless connection points with fast service speeds require oversized connections to the internet itself, 5G wireless is expected to become a huge growth driver for hardwired networking businesses as well — like the three optical network experts above.

Then, the important transceiver market was caught in the middle of a generational sea change: 40-gigabit transceiver modules, which used to be the top-of-the-line solution, got company from faster 100-gigabit modules. Some companies, including Lumentum and NeoPhotonics, have announced a path to 200-gigabit and even 400-gigabit modules as soon as 2019. Like the upcoming wireless standards, this evolution of optical module speeds is making large customers sit back and consider their networking infrastructure plans.

Finally, Chinese telecoms and networking equipment builders slowed down their fiber-optic component orders to nearly a standstill in 2017. Regulatory bodies in the Middle Kingdom were contemplating the same generational issues in wireless and optical networking as everyone else, and China’s heavy-handed regulation procedures put the brakes on all sorts of networking activity. On top of all that, some of China’s largest networking equipment vendors have been hit with (or are under consideration for) trade sanctions that would block them from doing business with American companies. Together, these issues weighed heavily on our fiber-optic networking protagonists because a lot of their products are shipped directly to China-based clients — or to down-home American businesses that depend on manufacturing services in China.

Image source: Getty Images.

All of these issues took significant steps toward resolution in May. The Trump administration said it might lift sanctions against Chinese networking company ZTE, a promise that was executed in June. The technical specifications for 5G wireless networking are nearly complete after four years of polishing, possibly paving the way to the first equipment designs in June and business-ready solutions as early as 2019.

Those are the main drivers behind the optical networking gains you see in the table above. All three of these companies also reported quarterly results in early May, confirming these positive developments and solid long-term market trends.

Now what

The industrywide turnaround has arguably started and looks ready to gain momentum. In particular, NeoPhotonics is struggling to regain market momentum with a 21% negative return over the last 52 weeks. That pressure won’t lift until the 5G wireless specification gets that final shelf-ready announcement, paving the way for a return to normal business growth in China.

Lumentum and IPG Photonics are highly respected giants in their respective fields while NeoPhotonics remains a tempting but riskier turnaround bet. I’d be comfortable with owning all three today, and the events of last month only strengthened my conviction.

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Anders Bylund owns shares of NeoPhotonics. The Motley Fool owns shares of and recommends IPG Photonics. The Motley Fool has a disclosure policy.

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