Technically, Cree Is a Sell

Technically, you should sell Cree (Nasdaq: CREE) right now.

We examined the company using Moving Average Convergence-Divergence (MACD), which is one of the most popular and long-used technical analysis indicators. Technical analysis is the field of buying and selling stocks not based on the underlying merits of a company, but rather on the patterns and formulas around its price movements.

Signal line crossover is one of the more common ways to interpret MACD. It uses a series of moving averages (in this case, nine, 12, and 26 days) to look for bullish and bearish crossovers that indicate a stock has momentum in one direction or another. Below you can find a current chart of Cree's MACD profile:

Confused? Well, that's preposterous! How could you ever be confused by something as simplistic as a Moving Average Convergence-Divergence chart! OK, we're jesting -- but in all seriousness, this is actually one of the simpler methods for technical analysis.

Still, if you'd strictly followed the rules, seeking out upward and downward momentum, you would have seen the stock move between buy and sell categories a fantastic 25 times!

A better way to size up companies
Here at Fool.com, we're more interested in other measures of company value. When we look at Cree and its peers, here are the areas that interest us:

Source: Capital IQ, a division of Standard and Poor's; TTM = trailing 12 months.

We prefer to look at the fundamental drivers of value. Investors should closely watch statistical fields like return on equity, as well as qualitative values like competitive advantage and managerial effectiveness. These areas led investors like Warren Buffett and Seth Klarman to decades of outperformance. Buying and holding great companies is the best solution for individual investors to build lasting wealth and achieve their financial goals.

So when you look at Cree, don't evaluate it for crossing a momentum line. Buy or sell it because:

• There's no stopping the march of LED lighting, and that's the way Cree likes it. Cree is a leader in LED lighting, riding the technology's adoption to dizzying heights. Last quarter, the company reported sales growth of 79% year over year . The big sales pitch around LED lighting is that while initial costs are higher, LED provides large cost savings over the lifespan of the bulbs. For companies like Wal-Mart with a long-term focus, the merits of LED bulbs are easy to sell. For consumers, the up-front costs may be intimidating. However, government mandates are providing tailwinds for efficiency movements that should spur LED adoption. The U.S. adopted new energy regulations mandating that light bulbs must be 25%-30% more efficient by 2012, and 70% more efficient by 2020. Similar regulations are being enacted across the developed world.
• LED lighting has several other uses beyond lighting buildings. The technology is also used in screens for mobile technology, household appliances, street lights, and even barcode readers. Cree is experiencing booming demand across several end markets.
• However, Cree also trades at a trailing P/E of around 65, and even with optimistic forecasted growth, it commands a forward P/E of 31 . A high P/E is expected for a leader in an emerging technology like LED, but Cree should face stiff competition in the coming years. GE, Phillips, Samsung, and LG are all increasing their presence in the LED arena. Cree might have phenomenal pricing power with constrained supplies right now, but stiff competition from larger firms building out their capacity could quickly erode that situation.

Want to sell Cree based on technical merits today? Technically, odds are that you should flip and buy Cree sometime very soon. If that sounds like madness to you, well, we here at Fool.com agree. In every market decline, technical analysis gets its share of proponents. The cries that "buy-and-hold is dead!" get louder, and individuals race toward schemes that promise greater wealth in a shorter amount of time.

I don't deny that technical analysis could make investors money. In any random short-term transaction, you're essentially playing a 50/50 game of chance. However, at the same time, most technical analysis schemes are a relatively simple science, eliminating the vast complexities of evaluating true company value. However attractive, this theory is ultimately the wrong path for individual investors. Technical analysis relies on long-held beliefs about exploiting momentum and consistent patterns throughout the market.

However, with as much as 75% of market trading now done by Ph.D-level programmers at massive high-frequency funds, even if opportunities existed, what chance would an individual have to sniff these deals out? With so much volume now driven by these funds, how can you be certain the same rules of patterns still even exist?

I could also point to Massey University's study across 49 countries, which showed that more than 5,000 trading rules add no value. However, the real reason to forget about technical investing is what we mentioned earlier: Cree crossed the crossover 25 times across the past year! While traders might not buy and sell with each crossing, cases of high momentum are normally short-lived. The amount of trading in most technical analysis schemes racks up commission fees and short-term capital gains taxes, eating away at profits. More importantly, it takes away from the idea of holding a portfolio of great companies that can accrue wealth over a long time horizon.

That's why, at Fool.com, we recommend that individual investors establish a portfolio of well-managed companies with strong advantages over their competitors. In the end, we find that to be the best contributor to long-term wealth. More importantly, it'll spare you from sitting bleary-eyed in front of a computer with a Big Gulp full of coffee, frantically buying in and out of companies. But hey, if your idea of protecting your future is charting the ups and downs of Moving Average Convergence-Divergence charts, then Cree looks like a sell right now. Just don't expect to part with it for very long.

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