Finisar: Not Buying the Bulls

NEW YORK ( TheStreet) -- In July, shortly after Finisar ( FNSR) posted an unassuming fourth quarter report that capped a feeble fiscal year, I wasn't sure if it was the right time to buy the stock. Finisar's earnings results failed to spur my buying decision, though the better-than-expected numbers from Ciena ( CIEN) were hard to ignore. Factoring the positive words from Cisco's ( CSCO) CEO John Chambers, who hinted at a broad recovery in carrier spending, shares of Finisar immediately appeared undervalued.

While I've always wanted to like Finisar, jumping on the stock simply because of Ciena's and Cisco's confidence made little sense to me. Cisco's optimism, while encouraging, has very little to do with Finisar's business and any near-term value the company's management is able to harvest. And while Finisar has a decent lead in the optical components space, management has never demonstrated that it can reliably convert this type of advantage into significant free cash-flow. I didn't buy the stock. It's a decision I've come to regret.

Since the July article, not only have shares of Finisar soared more than 46%, the stock received an upgrade on Tuesday from Jefferies analyst James Kisner, who boosted his price target by $11 a share. Kisner cited (among other things) "demand for high-speed optical products will keep growing through 2014."

Kisner, whom I greatly respect, is being a bit too bullish. While some of these gains can be attributed to better outlook in enterprise spending, I don't believe that the extent of Finisar's 46% surge in only three months jibes with any real evidence that robust carrier spending will persist. Nor can we expect that this spending, should it return, will continue to outperform.

I will grant that the overall telecom space seems healthier. It's also encouraging that the likes of AT&T ( T) and Verizon ( VZ) are committed to investing in 4G LTE (long-term evolution) technology. The problem is that the Street was just as eager about these prospects last December, suggesting that Finisar (and others) were poised to rebound on improved network expenditures. It never happened.

Instead, investors who hopped on the bandwagon were stuck with a stock that barely moved. So my hesitation with recommending the stock in July was based on fears that I was about to be fooled again. On the bright side, the company did grow revenue in this recent quarter by 9.3%, while earning 31 cents a share to meet Street expectations. Here again, however, for a stock that is trading at a price-to-earnings ratio of 83, which is more than 4 times that of rival Avago ( AVGO), profits have to be better than meeting expectations to justify the premium.

When you consider that Avago posted a higher rate of sequential growth in the comparable quarter (15% vs. 9.3%), the valuation question for Finisar again comes into play. The good news for investors is that Finisar continues to build strong operating leverage. That non-GAAP gross margins expanded sequentially by 290 basis points serves as a perfect example.

What this tells me is that even in the face of stiff competition from the likes of JDS Uniphase ( JDSU), Finisar management continues to make meaningful advancements in terms of customer loyalty. As the carrier spending environment continues to recover, keep an eye on to what lengths Finisar will go to preserve its strong margins. As evidenced by the better-than-expected guidance, the company appears poised to boost sales given its recent upgrade cycle.

For a company working hard to earn the Street's respect, Finisar's stock price and its high P/E suggests that it has the Street's attention. But the company is not out of the woods yet. As I've said, we've seen this pattern once or twice before. And with political wrangling in Washington, corporate budgets, on which this stock is trading, are anything but safe. I would tread cautiously here.

At the time of publication, the author held no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.
Richard Saintvilus is a co-founder of StockSaints.com where he serves as CEO and editor-in-chief. After 20 years in the IT industry, including 5 years as a high school computer teacher, Saintvilus decided his second act would be as a stock analyst - bringing logic from an investor's point of view. His goal is to remove the complicated aspect of investing and present it to readers in a way that makes sense.

His background in engineering has provided him with strong analytical skills. That, along with 15 years of trading and investing, has given him the tools needed to assess equities and appraise value. Richard is a Warren Buffett disciple who bases investment decisions on the quality of a company's management, growth aspects, return on equity, and price-to-earnings ratio.

His work has been featured on CNBC, Yahoo! Finance, MSN Money, Forbes, Motley Fool and numerous other outlets.

If you liked this article you might like

Apple Readies Likely Huge Capital Return Program, and Rivals May Soon Follow

Apple Readies Likely Huge Capital Return Program, and Rivals May Soon Follow

Top Tech Stocks to Buy Now on These Megatrends

Top Tech Stocks to Buy Now on These Megatrends

Wall Street Freaks Out Over Possibly Weak Apple iPhone X Sales

Wall Street Freaks Out Over Possibly Weak Apple iPhone X Sales

Apple Is More Willing Than Ever to Cut Large Checks to Suppliers and Startups

Apple Is More Willing Than Ever to Cut Large Checks to Suppliers and Startups

Here's One Surprising New Way to Invest in Apple

Here's One Surprising New Way to Invest in Apple