I'm a believer in growth stocks. As an analyst for our Motley Fool Rule Breakers service, I think you should be a believer too. But even I have to admit some growth stories are bogus, hence this regular series.

Next up: Ciena (Nasdaq: CIEN). Is this supplier of communications equipment the real thing? Let's get right to the numbers.

Foolish facts



CAPS stars (out of 5) **
Total ratings 548
Percent bulls 86.5%
Percent bears 13.5%
Bullish pitches 65 out of 81
Highest rated peers Digi International, Spirent Communications, Network Engines

Data current as of Jan. 20.

Most Fools think little of Ciena's model, and for good reason. The company hasn't produced profits or meaningful cash flow since 2008, and its record in the years before is spotty at best. CEO Gary Smith has a plan to change all that, but doing so will require flawless execution and smart integration of assets acquired from Nortel Networks (NYSE: NT). This is a company with a lot to prove.

And yet the idea behind Ciena makes sense. Unlike Cisco Systems (Nasdaq: CSCO) or Juniper Networks (Nasdaq: JNPR), Ciena pitches whole platforms of optical networking gear with programmable software for handling complex data loads and high volumes over a long distance. Exactly the sort of infrastructure you'd expect for the modern Internet, in other words.

"Having spent 30-plus years working for a very large telco I can attest to the fact that a paradigm shift in telephony is occurring today. As subscribers abandon their copper-fed home telephone service in favor of cell phones, the remaining pipe to that home is DSL. Those DSL connections are rapidly being converted to naked DSL -- that is, a DSL pipe that does not require an associated telephone number on the copper cable pair," wrote Foolish investor ssouvigny in April.

The implication? Consumers and business are unplugging copper-dependent services, and in the process making room for fiber-enhanced services. Ciena's equipment was built to deliver data over fiber.

The elements of growth


FY 2010

FY 2009

FY 2008

Normalized net income growth Not measurable Not measurable (34.2%)
Revenue growth 89.5% (27.7%) 15.7%
Gross margin 40.2% 43.6% 50.6%
Receivables growth 190.6% (14.6%) 33%
Shares outstanding 94.1 million 92 million 90.5 million

Source: Capital IQ, a division of Standard & Poor's.

Not surprisingly, there isn't much to like about Ciena's performance over the past three years. Let's review:

  • Revenue growth has accelerated recently but more sales have yet to equal a corresponding gain in profits. Growth at any price isn't what I'm after.
  • But that seems to be exactly what Ciena is after. Gross margin is down more than 10 percentage points over the past two fiscal years. Returns on capital are down by even more than that over the same period. Ouch.
  • A massive jump in receivables may be the only good thing in this table, and even that's no sure bet. The gain could either reflect recent demand for Ciena's expensive gear -- recent enough demand that clients haven't yet paid their tabs -- or poor collections on the part of the company. Either way, there's risk here.
  • Ciena's rising share count isn't as troubling because it isn't surprising. With cash not yet flowing, the company has little choice but to issue shares and debt to fund operations.

Competitor and peer checkup


Normalized Net Income Growth (3 yrs.)

Alcatel-Lucent (NYSE: ALU) Not measurable
Ciena Not measurable
Cisco (1.5%)
Nortel Networks Not measurable
Sycamore Networks (Nasdaq: SCMR) Not measurable
Tellabs (Nasdaq: TLAB) 35.5%

Source: Capital IQ. Data current as of Jan. 20.

By the numbers, Tellabs appears to be the class of this group. But that may not be saying much. Instead, I wonder if it reveals the weakened position of capital equipment suppliers in a lousy economy. So much of tech is services-oriented now. Are chief information officers (CIOs) still interested in big hardware purchases? I'm not so sure.

Grade: Unsustainable
For Ciena, how CIOs spend their budgets is less of a concern. Carriers and federal agencies supply the company with most of its revenue, and they're likely to continue demanding the heavy-duty gear Ciena is pitching. They're the ones most in need of a faster Internet backbone.

How long and how much they'll spend is anyone's guess, and that's a problem for me as an investor. I'd rather see improving margin and cash flow trends before taking a flier on an old tech horse that's still learning new tricks.

Now it's your turn to weigh in. Do you like Ciena at these levels? Let us know what you think using the comments box below. You can also ask me to evaluate a favorite growth story by sending me an email, or replying to me on Twitter.

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Interested in more info on the stocks mentioned in this story? Add Ciena, Alcatel-Lucent, Cisco, Nortel, Sycamore Networks or Tellabs to your watchlist.

Our Motley Fool Big Short service has recommended shorting Juniper Networks. Motley Fool Alpha has a real-money short position in Juniper Networks, and owns shares of Cisco Systems.

Fool contributor Tim Beyers is a member of the Motley Fool Rule Breakers stock-picking team. He didn't own shares in any of the companies mentioned in this article at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. You can also get his insights delivered directly to your RSS reader. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a bull call options spread in Cisco. The Fool is also on Twitter as @TheMotleyFool. Its disclosure policy thinks Monty Python is sustainably funny.