Why Shares In Imagination Technologies Group Plc Tanked

Although we don’t believe in timing the market or panicking over every stock fluctuation, understanding how a business is performing, competing and changing is vital to sensible investment.

What: Shares of Imagination Technologies (LSE: IMG) crashed by 16% in early London trade this morning, after the graphics chip designer revealed a surprise £1.1m loss for the six months up to November, and lowered its guidance for the year.

So what: Valued at more than £550m, Imagination is expected to double its earnings per share in 2014, with another 45% leap anticipated by analysts the year after. There’s little doubt that Imagination is priced as a “growth stock” — any news that things are getting worse and not better will not be welcomed by investors.

Now what: Shareholders will need to look beyond the headline numbers in the short-term, which will ultimately have little bearing on Imagination’s true potential five to seven years from now.

Imagination’s gross profit actually climbed by 23% to £74m over the period, as revenues grew by 20% to £85m. The brunt of the declines in reported profits came as a result of much higher research spending of £56m, which the company doesn’t appear to be paying out blindly:

“Investment in R&D remains critical to the success of the business. We continue to use a combination of organic growth and small scale acquisitions to develop the technology and capability to achieve our strategy. In the first half we have tightly controlled the rate of investment to ensure the operating cost base is effectively managed.”

While Imagination faces an uphill battle to meet the expectations baked into its current valuation, there’s an extent to which investors here should be less focused on business results today — but instead on the company’s future market position in this growing industry.

Meaningful investment in research will be crucial to achieving that, and while the market is disappointed today, Imagination will ultimately live or die by the progress it can make in new products… which scarily, probably haven’t been invented yet.

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> Mark does not own Imagination. The Motley Fool owns shares of Imagination.