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Should you pile into IQE plc, down 15% today?

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Investors in IQE (LSE: IQE) have enjoyed a great run, from below 17p per share in July 2016 to a little over 175p per share in November 2017, that’s a rise of around 930%. However, today’s share price is down – to 105p, as I write – representing a fall of 40% or so from November’s peak – ouch!

If you missed the first wave of excitement, is this dip a second chance to pile in for the next climb as the firm’s growth potential plays out? I’m interested, but cautious, and here’s why…

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A compelling tale

IQE’s story is a good one. The firm earns its living by manufacturing advanced wafers for the semiconductor industry. By reading company statements, it becomes clear that the directors believe it enjoys a well-protected niche in the industry and is able to defend it with accumulated expertise and intellectual property.

In November, the firm raised £95m in a placing, at a price of 140p per share, in order to ramp up capital expenditure aimed at scaling the business for “multiple high growth mass-market opportunities.”  

The directors see Vertical Cavity Surface Emitting Laser’s (VCSEL) – a key component in fibre optic communications devices – as being a long-term growth driver for IQE across a range of applications such as sensing, Light Detection and Ranging (LDAR), optical communications, machine vision and heat assisted magnetic recording.

In December, chief executive Dr Drew Nelson said: “The adoption of VCSELs in the mass market has been a key revenue driver in the year.” Indeed, the firm is the only supplier of epitaxial wafers to Apple for the consumer technology giant’s TrueDepth 3D camera, which could lead to rapid growth in revenues and profits generated from both Apple and its competitors, if they take up IQE’s offering. If we do end up seeing the acceleration of IQE’s products in mass-market smartphones and other applications, we could witness profits multiplying many times down the road.

An interesting valuation now

It seems clear that the stock rose in anticipation of this positive forward vision, but the reversal we are seeing now suggests speculation pushed the share price ahead of events. Perhaps we’ve just seen a bubble in the price. Today’s 105p is far more realistic.

At this level, the historic price-to-earnings rating is 32. Meanwhile, City analysts following the firm – who seem equally as excited by the firm’s forward prospects – expect earnings to grow by 29% during 2018, and by 44% in 2019, which suggests acceleration that may, or may not, continue.

I think the valuation is now interesting. But we’re dealing with a very popular stock here, and I reckon it’s important to take account of sentiment and psychology as well as fundamentals when making buying and selling decisions.

For me, it makes no sense to buy a stock that is still falling, so I’d want to see some kind of base form on the chart and evidence that the share-price trend has reversed, such as two or three higher lows and higher highs on the chart. Remember, prices can move much further than we believe possible in either direction, and this is just the type of stock where that effect is likely to be most evident.

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Kevin Godbold has no position in in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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