As investors, we're often told that it's reckless to chase rallying stocks. While that's certainly true in some cases, investors sometimes miss out on big gains because they were afraid to buy stocks hovering near fresh highs.
A "hot" stock is usually on fire for a reason. Investors should keep an eye out for ones that are gaining momentum for a solid reason and trading at reasonable valuations. Let's take a closer look at three stocks that fit that description: Applied Optoelectronics (NASDAQ:AAOI), Tucows (NASDAQ:TCX), and STMicroelectronics (NYSE:STM).
Applied Optoelectronics provides fiber-optic networking products for the data center, cable television, and fiber-to-the-home markets. The company has consistently posted double-digit year-over-year sales growth in recent quarters, thanks to a "super cycle" boosting demand for higher-speed optical components across the market.
This cycle is caused by companies facing bandwidth bottlenecks due to the rising usage of streaming video, cloud-based apps, application virtualization, and other data-intensive tasks. That's why research firm Markets and Markets expects the size of the optical networking and communications market to more than double from $12.6 billion in 2013 to almost $26 billion in 2020.
Applied Optoelectronics' revenue rose 23% annually during the third quarter, and its preliminary fourth-quarter report (released on Jan. 11) indicates that revenue will rise another whopping 60%. Analysts now expect the company's revenue to rise 37% this year and another 28% next year. Non-GAAP earnings are expected to grow 24% this year and 58% next year. Those bullish expectations have caused Applied Optoelectronics shares to soar more than 35% since the beginning of the year.
Tucows is a provider of internet services, offering a platform for selling and integrating domain names as well as wireless and home fiber services under its Ting Mobile and Ting Internet brands. Those businesses might sound like slow-growth ones, but it recently announced that it will acquire wholesale domain registrar eNom for $83.5 billion. That move, which combines eNom with its reselling platform OpenSRS will make it the second-largest domain registrar in the world and be "immediately" accretive to its earnings growth.
Meanwhile, the Ting Mobile brand has been carving out a niche market with partnerships with major retailers like Staples and Kroger, while Ting Internet's fiber plans are making inroads into smaller towns and cities across the U.S. These catalysts have caused Tucows' stock to surge 35% since the beginning of the year.
Analysts expect Tucows' revenue to rise 85% this year, thanks to the additional revenue from eNom, and grow another 10% next year after year-over-year comparisons normalize. Its earnings are expected to grow 28% this year and another 52% next year.
STMicroelectronics is a French-Italian chipmaker that manufactures a wide range of semiconductors for the automotive, industrial, security, and consumer electronics industries. Its automotive division is its largest business unit, and has been growing rapidly on content share gains in connected cars. It also produces motion sensors for smartphones, tablets, and other consumer electronics.
STMicro's revenues have risen year-over-year for two straight quarters, breaking a multiyear streak of revenue declines. That rebound was sparked by growing demand for its chips across multiple industries, especially in automotive chips and analog chips and motion sensors for consumer electronics. The strength of those businesses offset softer sales of microcontrollers and digital ICs last quarter, and boosted its revenue by 11% annually -- marking its strongest growth rate in several years. Its earnings of $0.15 per share were also a huge improvement from its flat earnings in the prior-year quarter.
Analysts expect STMicro's revenue to rise 8% this year and 5% next year. Its earnings are expected to rise 121% this year, thanks to its return to top-line growth, and another 17% next year. Those rosy forecasts have boosted STMicro's share price by 20% since the beginning of the year.
But mind the valuations
Applied Optoelectronics, Tucows, and STMicro have all delivered impressive returns this year, but investors should keep an eye on their valuations. Applied Optoelectronics trades at 29 times earnings, which is higher than its industry average of 22. Tucows' P/E of 31 is lower than its industry average of 50, but STMicro trades at 77 times earnings -- which is much higher than the industry average of 22.
Those multiples initially look high, but they're not terribly pricey relative to their past and estimated earnings growth. Therefore, investors who are interested in these "hot" stocks should dig deeper to see if those rewards can outweigh their near-term risks.