Earlier this month, NVIDIA (NASDAQ:NVDA) announced that it would invest $2 billion in optics and photonics maker Lumentum Holdings (NASDAQ:LITE), as well as make a purchase agreement for laser components from the company worth multiple billions of dollars. NVIDIA’s decision to invest capped off a remarkable run for Lumentum, which has been among the best-performing stocks of the past year. Why did NVIDIA invest in Lumentum, and does LITE still look like it could be a good buy for retail investors?
Why Lumentum Could Be Crucial to AI Development
As AI infrastructure has been built out over the past few years, the technology’s computing demands have called for some fundamental changes in how data centers are set up. Among these is a transition away from copper connections to optical ones, facilitating higher speeds and greater scalability. A large part of this transition has been the deployment of optical circuit switches, which allow for higher bandwidths over longer distances.
This is where Lumentum comes in. As a major OCS manufacturer, Lumentum is primed to benefit enormously as more data center components make the jump from copper to optical connections. By 2029, the market for OCSs is expected to reach $2.5 billion or more, creating massive addressable market growth for Lumentum. This growth in optical switching was likely a key driver in NVIDIA’s decision to invest in Lumentum now, as more production will be needed to meet the expected needs of the AI data centers that will be built in the coming years.
Lumentum is also a leading force in co-packaged optics, another high-growth technology that is benefiting from data center demand. In CPOs, optical components are packaged alongside integrated circuits, reducing the length of the electrical connections between the two. The growth of CPOs over the next few years is expected to be explosive, with the market projected to grow from less than $400 million in 2024 to about $2.9 billion by 2032.
Lumentum’s Current Growth and Outlook
Unsurprisingly, Lumentum’s potential is already translating to extremely strong growth. In its fiscal Q2, the business reported net revenues of $665.5 million, up 65.5 percent from the year-ago quarter. Net income for the quarter was modest at $4.2 million, but it was still a massive improvement on the $60.9 million Lumentum lost in Q2 of FY2025. Non-GAAP EPS, meanwhile, came in at $1.67 per share.
For fiscal Q3, Lumentum expects a continuation of the extremely strong momentum it saw in Q2. Revenues are projected to fall between $780 million and $830 million, while non-GAAP earnings per share are projected to rise to between $2.15 and $2.35. It’s also worth noting that Lumentum now has a backlog of over $400 million driven by OCS demand.
Looking out over the next 3-5 years, analysts expect Lumentum’s EPS to rise at a CAGR of about 100 percent annually. This massive expected growth rate accounts for the leap LITE shares have seen over the past 12 months, as investors are now pricing in very large increases in future earnings. Given the expected growth of OCS and CPO demand into the 2030s, it’s also quite possible that Lumentum could see strong earnings growth rates stretching well into the next decade.
Is Lumentum Overvalued?
With investors increasingly turning to stocks in businesses that make hardware for data centers, LITE shares have gained over 900 percent in the past 12 months, raising real questions about the stock’s valuation. Today, Lumentum is trading at almost 200 times its trailing 12-month earnings and over 23 times sales.
While it’s rare for a stock to be able to support such a high valuation, analysts remain remarkably positive when it comes to LITE. The average price target for Lumentum shares is $660.32, roughly 3 percent above the most recent price of $640.69. The consensus rating on LITE is also still a buy, with 14 analysts issuing buy ratings and four issuing holds. As of the time of this writing, no analysts currently rate Lumentum stock as a sell.
In looking at LITE, it’s important to consider the extremely high rates of earnings growth that are expected to occur over the next few years. With earnings essentially set to double annually as demand for OCS and CPO hardware ramps up, Lumentum enjoys an unusually positive outlook that may be able to help it justify valuations that would otherwise be unsustainable. Even so, the extremely high growth expectations now baked into the price of Lumentum could present downside risk to investors if the business fails to deliver on its expected earnings growth.
Is Now the Time to Buy Lumentum?
From NVIDIA’s perspective, the decision to invest in Lumentum seems like a fairly straightforward one. With more and more data center hardware moving toward optics, investing in a leading optics and photonics manufacturer supports NVIDIA’s long-term goal of pushing the boundaries of computing and building advanced infrastructure for AI. NVIDIA may also be able to leverage the R&D Lumentum is conducting to improve its own technology going forward.
With that said, NVIDIA doesn’t seem to be putting all of its eggs in one basket when it comes to optical components for AI data centers. On the same day as the investment in Lumentum was announced, NVIDIA also announced a similar investment and purchase agreement with Coherent (NYSE:COHR), another leading photonics manufacturer.
While there seems to be little doubt about Lumentum’s growth runway, the stock may already have had most of its potential upside priced in. Especially in the wake of NVIDIA’s decision to invest, Lumentum’s valuation leaves it little to no margin for error, making the stock a bit of a risky investment based mostly on expectations of future growth.
Despite a high price tag, LITE could be a good stock to revisit if and when its valuation comes down to slightly more reasonable levels. The business will likely remain attractive while the current spate of AI infrastructure building continues, and investors may want to watch for more appealing entry points later on.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.