Lumentum

Where we land

Lumentum makes laser chips that sit inside the links connecting the computers in AI data centres, and that business has transformed the company in a year. The line that houses it makes 86% of sales; sales rose 83% in a year, and operating profit swung from a 180m loss to 539m. We award it gold.

We are just as clear about the price. The shares already sit among the dearest of all the companies we rate, so the question is less whether this is a good business right now than how much good news the market has already paid for.

What the business is

Lumentum sells two kinds of thing. By far the larger is optoelectronic components, parts that turn electrical signals into light and back again, which bring in 86% of revenue. The remaining 14% comes from lasers and optical instruments sold as products in their own right. Inside the components line sit the laser chips for data centres that drive today's story, alongside parts for telecom networks and 3D sensing; our figures do not split those apart.

Today the business keeps 40% of each sale after the direct cost of making the product, its gross margin, and 18% after the cost of running the company, its operating margin. Those are healthy numbers, but not the company's usual ones. Over the past five years its gross margin has had a median of 30% and typically wandered 11 points either side of that. This is not a stable-margin business: when demand is strong and factories are full, the margin climbs; when demand fades, it falls back, and profit that looked durable thins quickly.

Why now

Cloud companies building clusters of AI computers need enormous numbers of high-speed optical links to move data between machines. Each link runs through a transceiver, a small module that converts electrical signals to light and back, and Lumentum's laser chips sit at the heart of those transceivers. As the clusters have grown, so has demand for the chips.

Two developments make the moment unusual. Lumentum says its capacity for these optical parts is sold out to 2029, so demand is no longer the constraint on growth; how fast it can build production is. And repeated reports of commitments from Nvidia, the dominant maker of AI chips, place Lumentum near the centre of spending on AI optics rather than at its edge.

Its growth over the past year has moved up sharply against every listed company. It has been held in our Conviction 10 portfolio since August 2026 and still qualifies to stay there.

The case for

The strongest argument is visibility. An October headline reported that the company sees its optical component capacity fully booked through 2029, following an August report that sales had more than doubled on AI demand. For a business whose results have swung widely, seeing years of orders ahead is a genuine change in character, if it holds.

The second is the customer. Headlines have repeatedly described an optics deal with Nvidia, Nvidia commitments and Nvidia backing, alongside a new facility built for AI work. That is a specific, named relationship with the company setting the pace in AI hardware. Our evidence does not show the contract terms or how hard it would be for Nvidia to go elsewhere, so the tie is real but its strength cannot be measured from outside.

The third is the speed of the turn. Sales grew 83.2% over the past year, far ahead of the 19.5% a year managed over three years. Analysts' consensus sees earnings per share rising about 61% next year, though from a base distorted by a below-the-line loss, and every one of the ten forecast changes in the past 45 days was an upgrade. Over six months the company's growth standing has gone from the bottom of the market to the upper third, which looks like a breakout into something new rather than a bounce back to old levels.

Where the growth could come from

The engine now is plain: laser chips for AI data-centre links. With capacity sold out, growth is set by how quickly Lumentum can add production, and tight supply tends to support prices, which can lift margins as well as sales. The proof would be new capacity showing up as higher shipments, with gross margin holding or rising as volumes grow.

The next leg could come from co-packaged optics. In the next generation of AI switches, the optics move right up against the chip, and that design needs powerful lasers supplied from outside the package. Lumentum is positioned as one of those suppliers, with Nvidia named as a backer. Revenue here is likely small today, but it would keep Lumentum central even as transceiver designs change, rather than leaving its runway exposed to a shift in technology. Volume shipments into such switch systems, named in results or by customers, would show it arriving.

A further option lies in optical circuit switches: equipment that reroutes light across a network without converting it into electrical signals, saving power in large AI clusters. Lumentum has developed such a switch. It is a bigger-ticket system than a component, and repeat orders from large data-centre operators would add a growth line and spread the company's reliance beyond laser chips. Announced production orders or deployments with a major cloud customer would confirm it.

The pattern also fits a move up from chips to complete transceiver modules assembled in-house and sold to cloud customers. That can add revenue quickly and deepen relationships, but modules earn thinner margins than chips, so the mix decides how much sales growth becomes earnings growth. Module sales rising alongside a steady or improving overall gross margin would show the trade-off working.

The case against

Start with the price. The whole company, debt included, is valued at 24.9 times its sales and 139.3 times its operating profit, and the shares trade at 16 times net assets on the books, near the most expensive end of the market. Headlines have begun to flag stretched valuations and a test of expectations, and while the shares have been rising strongly, that upward pull has weakened over three, six and twelve months. With forecasts already calling for strong growth and every recent revision upward, results that merely meet hopes can disappoint.

Then the peers. Lumentum's 40% gross margin and 18% operating margin now sit in line with Amphenol, Corning, Delta Electronics and Murata. But those companies earned their margins steadily through the past five years, while Lumentum has only just reached them. Matching peers at the top of a boom is not the same as matching them across a cycle.

The record is short. The company made operating losses in each of the years to June 2023, 2024 and 2025 before this year's 539m of operating profit. What turned it was AI demand filling its factories; whether the profit lasts depends on that demand outlasting the new capacity being built to meet it. The business has never shown it can hold today's margins through a downturn.

The reported result compounds the difficulty. This year's 6.9bn net loss comes from items below the operating line, such as financing costs, one-off charges or accounting items, so the operations themselves are profitable, but the company has no meaningful price-to-earnings multiple and our quality measures place it near the bottom of the market. An investor cannot lean on reported earnings to check whether the price is reasonable.

Finally, the shares are hard to hold. Optical stocks have become one of the most volatile corners of the AI trade, called its wildest ride in a July piece, and Lumentum's shares jump and slump on hints about customer spending and supply: within October alone, one day the stock sank and on another it soared 8.2%. Any slowdown in cloud spending on AI would hit them hard.

What the price assumes

Lumentum's earnings have moved too unevenly to show a trend worth carrying forward, so we ask instead what the current price needs. For the shares to look ordinary in five years without rising at all, earnings would have to compound at 16% a year, at which point the company would trade at 18.5 times earnings, the median of every profitable listed company we cover.

Against the forecast of about 61% earnings growth next year, that hurdle can look modest. But the starting earnings are distorted, and five years is long enough to include a turn in the AI spending cycle, which in this company's past has meant falling margins. The requirement is growth sustained through whatever comes after the current boom.

The share price has already done much of the anticipating: up 317% over the past year, though down 11% over the past six months, a sign the market has started to weigh how much more is left to pay for.

The other side of the medal

The risk we would watch above all is that the price assumes the AI boom keeps Lumentum's laser capacity sold out, in a business whose gross margin has swung 11 points with past cycles. At today's valuation there is little room for the margin to fall back towards its old median.

The returns show why this risk matters most. Return on shareholders' equity is currently -149%, dragged down by the below-the-line loss, and return on invested capital has a five-year median of about zero. Over a full cycle, Lumentum has not yet shown it earns a return on the money it uses. The present boom is the first real test, and the price assumes it passes.

The risk would announce itself first in margins and orders, not headlines: customers stretching out or trimming bookings, new capacity coming online faster than demand absorbs it, and gross margin slipping even while sales still grow.

What to watch

The single most telling figure is gross margin: 40% today against a five-year median of 30%. If it holds at or above that level as new capacity ships and lower-margin modules grow, the boom is turning into a better business; if it slips while volumes rise, the old cycle is reasserting itself.

Before that shows in results, the signals sit with customers. The big cloud companies' published data-centre spending plans fund every order Lumentum takes, so a pause or cut there would reach its order book soon after. Lead times matter too: while capacity stays booked years ahead, customers are competing for supply, and shortening waits or freed-up slots would mean demand is easing before sales do. Named volume orders for co-packaged lasers or optical switches would show the next legs taking shape.

We would be wrong if AI customers, Nvidia among them, cut or deferred orders so that the sold-out capacity went unfilled, sales growth stalled and operating margin slid back towards the losses of 2023 to 2025.

The numbers

Qualifications that apply to every figure above: operating profit is positive, but the reported net result is a loss from items below the operating line - financing costs, one-off charges or accounting items: the business is not losing money, and this year's earnings, and any multiple on them, are distorted; gross margin has varied by 11% around a 30% median: not a stable-margin business.

The same industry, for comparison

Research for information, not personal investment advice or a recommendation to buy, sell or hold any security: see Important information. Data as at 31 October 2026.