While compact fluorescent bulbs have been pushed by the government to the forefront as the next-generation advance in lighting, investors should consider them just a way station on the path to an even brighter future: LEDs. Lighting the way there is industry leader Cree (NASDAQ:CREE), whose second quarter earnings report was considerably brightened by a 62% increase in profits over the previous year.

Revenues of $147.6 million got a bit of a power surge from patent licensing fees of $5.6 million that Cree hadn't previously announced. Not bad in a period when prospects for many businesses appeared dim.

The strength of the LED product sales was underscored by the contract it signed with the Department of Defense to install more than 4,200 LED light fixtures in the Pentagon. It also points the way toward a catalyst for future growth. The contract may very well lead to similar deals in the future. It already has its lights installed in the Federal Reserve and with the cost savings the program is intended to generate, Cree may very well see its profile raised and more business come its way.

However the lighting specialist has indicated a number of non-life threatening reasons why third-quarter LED component sales are expected to be lower. For example, Cree has to contend with a shortened sales quarter due to an extended Chinese New Year shutdown at its customers. But the company is weathering market pitfalls better than rival Philips Electronics (NYSE:PHG), which is writing down its LED division Lumileds because of slack demand in the auto, TV, and mobile phone markets. Still, Philips wants to branch out from home electronics and is investing heavily in LEDs.

Even so, according to the market analysts at iSuppli, the overall LED market is expected to see revenues grow by almost 3% this year. That might not seem like much until you consider that the rest of the semiconductor industry is anticipating a 9.4% drop in revenues in 2009. A big part of that will still be in LCD TV's where General Electric (NYSE:GE) is trying to carve out a niche for itself. And Siemens (NYSE:SI) has expanded a Malaysian facility recently to double its present production capacity.

Pricing is one area where Cree has concerns regarding its margins. Competitive pressures as well as customer requests for more aggressive discounts in this economy may offset gains it realizes from improved factory yields.

With the consolidation that has occurred in the industry, investors also can't discount the possibility that GE, Philips, or even Siemens might find Cree an attractive target. Yet at 36 times forward earnings, Cree is not exactly a bargain. Yet for those wanting to get in on the LED leader, I'd suggest waiting for one of the market's manic downturns before shining a search light here.

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Fool contributor Rich Duprey does not have a financial position in any of the stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.