LG.Philips' Mixed Signals

Anyone who still thinks that the stocks of profitable companies go up while companies that lose money see their stocks tank, please tune in to LG.Philips (NYSE: LPL  ) now. Thank you.

Back when LG.Philips first debuted on the NYSE scene (this was nearly a year ago), the company had just finished reporting a huge gain in year-on-year profits -- up 200%. Meanwhile, the company's IPO underwriters were frantically slashing its debut price as demand for the stock offering evaporated. By the time the company came to market, the asking price for LG.Philips' ADRs had sunk from somewhere in the $30s all the way down to $15. And on the actual day of the IPO, the stock opened at just $14.40. Once again: The business was raking in profits for its owners, LG Electronics and Philips, but the stock price was disintegrating.

Fast-forward nine months. LG.Philips reported last week that in the first quarter of fiscal 2005, its sales had decreased 6% against its Q1 2004 numbers (although sales were up sequentially), and while the company still sold $2 billion in product, it didn't make a penny of profit -- but rather incurred a $78 million loss. So with the business now turned unprofitable, how's the stock faring, you ask? Oh, it's up about 50% in nine months.

Astounding.

I suspect the reason for the disconnect between earnings performance and stock performance at LG.Philips arises from investors' misplaced optimism that, as the price of flat-panel televisions declines, demand will go up, yielding profits. The optimism itself is warranted -- that's exactly what will happen in time. But I say "misplaced" because there's little cause to be optimistic that profits will accrue to LG.Philips or its brother flat-panel makers. Rather, I expect the company will fall into the same trap we've seen companies like American Woodmarkfall into in recent quarters. While they work in completely different industries, you see, LG.Philips and American Woodmark share the same strategic position: that of product makers, squeezed between raw materials producers on the one hand, and retailers on the other.

In American Woodmark's case, it's the lumber producers and Home Depot (NYSE: HD  ) eating away at its profit margins. But glass is the issue for LG.Philips, as well as for Sony (NYSE: SNE  ) and AU Optronics (NYSE: AUO  ) . Glassmakers like America's Corning (NYSE: GLW  ) and Japan's Asahi Glass will demand high prices for their glass on the components end. And retailers like Best Buy (NYSE: BBY  ) and Circuit City (NYSE: CC  ) will demand volume discounts on the retail side. Caught between an economic rock and a hard place, LG.Philips' profits potential will go to shards.

Want to learn more about the investment potential of the LCD producers? Read:

• LG.Philips Blows a Fuse
• Flat Panels Still Getting Flattened
• Corning Calls It Right
• Sony's Flat Faux Pas
• LG.Philips: This Side Up

Fool contributor Rich Smith owns no shares in any company mentioned in this article.