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By David Sterman

Talk about timely. Several colleagues of mine were recently discussing what investors should do when that stock you love seems like it already left the station. We ended up covering the topic on our sister site, InvestingAnswers.com.

As fate would have it, a company which I have long admired, but whose share price was simply too expensive to recommend, fell out of bed this week and is now down -40% since late April. That company is Cree (Nasdaq: CREE), which is transforming the lighting industry.

Mr. Edison's legacy

After a century of use, the incandescent bulb started to lose favor among builders as compact fluorescent lights (CFLs) arrived with much lower power consumption. But the honeymoon will prove to be short-lived. CFLs may save 65% of the juice needed to provide light when compared to old-fashioned incandescents, but Light Emitting Diodes (LEDs) are even better, representing an energy savings of 85% compared to incandescents.

That's the kind of energy saving we need in our bid to wean our dependence off of fossil fuels. The move to LED lighting has only recently begun, though industry titan Phillips predicts that LEDs will comprise 50% of the lighting business by 2015. That prediction could be premature by half a decade, but the trend toward LEDs is inevitable.

Thanks to impressive cost-saving opportunities, some are already approaching LEDs in a big way. China is in the process of retro-fitting street lights to house LEDS (though that effort was recently slowed when it became apparent that Chinese suppliers were providing shoddy goods with short life spans). And architects are increasingly designating LED lights into their plans.

For even faster adoption, these relatively expensive lights will need to come down in price. Rising manufacturing yields are helping that process along.

The Industry leader

Cree, which has been developing its LED technology for more than two decades, holds the most patents in the industry and offers the broadest set of lighting products. That has enabled the company to secure roughly 30% of the whole market. But growth for the broader industry in general -- and Cree in particular -- has only recently taken off.

Cree's annual sales didn't reach $400 million until 2006, and it took another three years to reach the $500 million mark. Yet fiscal (June) 2010 was a breakout year for Cree, as sales shot up +53% to $867 million. That lit a fire under the company's stock, pushing it up from $17 in late 2008 to around $80 this spring. Analysts started to speak of uninterrupted +30% to +40% annual sales growth in coming years, and no price was too high for these shares.

But there's no such thing as uninterrupted growth, as Cree noted in its just-released quarterly results. Sales in the company's first fiscal quarter rose +59% from a year ago to $268 million, but analysts were looking for +65% sales growth. That rate is likely to cool further to +40% in the current quarter. Shares, which had already been hit by profit-taking after such a strong run, took another blow and moved below the $50 mark.

There's an important lesson here. Any company that is subject to very high expectations can be quite vulnerable to any setbacks. Right now, analysts think Cree will still boost sales +40% in fiscal (June) 2011 and +30% in fiscal 2012. Forget that. Instead, simply expect that sales can grow at least +25% annually for a number of years to come as LED deployments take root around the world.

You want to own Cree for its pole position in an exciting new industry that will eventually generate billions in revenue. Cree's slice of that industry revenue may shrink, perhaps to 20%, as competition builds. Yet a smaller slice of a much larger pie is not a bad thing. Cree looks set to top $1 billion in revenue this year, $2 billion by fiscal 2013, and perhaps $3 billion a few years after that.

After the recent sell-off, shares now trade for about 18 times projected (June) 2012 profits. Profit growth will be bumpy, as the company is trying to offset price pressures with lower manufacturing costs. But Cree's technology lead should ensure it can post gross margins in excess of 45% in coming years. (They currently stand at 48%).

Solid growth, robust margins, industry-leading technology, potentially massive industry opportunity. These are all the characteristics of a winning stock. And that -40% haircut means it's time to pounce.

Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.

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Source: Cree: A Second Chance to Buy an Industry Game-Changer