So what: After posting record profits in 2014, which drove Micron's stock to highs not seen since the dot-com bubble, the stock has been declining all year. In June, Micron came up short of analyst estimates when it reported its third-quarter earnings, and its guidance was well below what analysts were expecting. DRAM average selling prices sank 10% during the third quarter, driven by a weak PC market.
What Micron sells, DRAM and NAND, are commodities, and during periods of oversupply, Micron's profits can easily turn to losses. The last period of major oversupply was during 2012, when Micron reported a loss of $1 billion, and investors are clearly concerned that DRAM pricing may not hold up going forward.
Now what: After the collapse of Micron's stock price during June, the stock appears inexpensive based on past earnings and future earnings estimates. However, if DRAM prices continue to fall faster than Micron can cuts costs, profits could fall far more than analysts are predicting.
Strong demand for smartphone DRAM is partially making up for weak demand for PC DRAM, but the balance between supply and demand is the ultimate driver of Micron's profits. With DRAM prices falling during Micron's third quarter, there's a real concern that oversupply could once again plague the industry.
Micron's decline may not be over. While the stock trades for just seven times the average analyst estimate for 2016 earnings, those estimates can come down in a hurry if DRAM prices continue to decline. And while there are only three major suppliers of DRAM today, the result of industry consolidation, Micron certainly isn't immune to DRAM oversupply.
Timothy Green has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. 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 disclosure policy.