CREE: Why I'm Staying Away from This Sexy Investment

| About: Cree, Inc. (CREE)

Light-Emitting Diodes, or LEDs, can be made to shine more brightly by increasing the power to them. This has the unfortunate effect of overheating the leads and shortening the lifespan of the LED. A similar effect may soon hit the stock of LED maker, Cree, Inc. (CREE.)

Since I began the tradition, Cree has been a mainstay of my annual portfolio of ten stocks for the next year, published each January (See the 2008 and 2009 lists. The Cree-free 2010 list is here.) LEDs have been among my favorite alternative energy technologies even longer.

While the S&P 500 fell 22%, and the Powershares Wilderhill Clean Energy Index (NYSEARCA:PBW) fell 60%, Cree rose over 210%. Despite my conviction that energy efficiency stocks should be a mainstay of a clean energy portfolio, the company's current valuation makes me think the company has come too far, too fast. At $55, the company is trading at a 109 trailing P/E ratio, and 39 forward P/E based on analysts' consensus estimates.

LEDs, in other words, have become sexy, and cautious investors stay away from sexy investments because they know that you often have to pay too much for them.

LED Overcapacity in 2011?

In addition to overvaluation, there is the additional problem of rapidly growing capacity in LED production. Many LED manufacturers raised money to build new capacity in 2009, and most of that capacity will come on line in 2011, possibly setting the stage for a shake-out like the one we have recently seen in the market for solar polysilicon, according to Canaccord Adams. Cree's valuation can only be justified by several years of extremely strong earnings growth, and an industry shake-out would slash Cree's profits. If investors begin to expect such a shake-out, the stock will have to fall.

Cree is still a good company. With no debt it is likely to survive any such shake out, and may emerge stronger because of it. Investors, however, will probably do better by taking their profits and waiting to get back in at a lower price. Ten Clean Energy Stocks for 2012, perhaps?

DISCLOSURE: No Position.