I Found a Billion-Dollar Market in My Backyard

The end-of-year holiday season is a time for memories and reflection, and I found myself engaging in a little of both the other day.

I was alone at the house and was stringing up some Christmas lights and found myself drifting back in time... to middle school and high school.

In seventh grade, I got my first part-time job - changing lightbulbs at an apartment complex. I also began designing and building custom light boxes using colored bulbs controlled with staggered timing switches.

In my freshman year in high school - for my electronics class - I put together a pretty sophisticated strobe light from a nice kit. That was my introduction to capacitors, diodes, and wiring diagrams.

There was a reason for this mental road trip.

You see, the lights that I was stringing up around the perimeter of my house the other day happen to use a very specialized technology.

And this specialized technology is something that I knew you'd want to hear about because it represents a massive profit opportunity.

Today I'm going to tell you all about the technology. And I'm going to show you one of the best stocks to buy to make money from it.

Home Improvement

Of course, I'm talking about LEDs, which stands for "light-emitting diodes."

As a veteran analyst out here in Silicon Valley, I know that this technology is state of the art. And as a consumer and lifelong electronics nut, I can honestly say this lighting is the most beautiful I've ever used. At our house this holiday season, LED lighting graces the family Christmas tree inside the house - and our Japanese maple tree out in the yard.

As I stood in our backyard, admiring my handiwork on a moonless night, I finally realized that this lighting technology is every bit as beautiful as it is efficient.

This is truly one of those rare instances where aesthetics and investing go hand in hand...

See, the low-heat glow given off by LED lighting will serve as the catalyst that helps this technology sweep the nation and become a billion-dollar-plus business by the end of this decade.

And it all started with the simple lightbulb...

My deep understanding of this field is one of the reasons why I'm such a big fan of Cree Inc. (Nasdaq: CREE). Founded in 1987, the Durham, N.C.-based company introduced its first LED just two years later - long before the nation was ready to accept this technology for everyday use.

Particularly back then, LEDs represented a huge advance in technology, but the applications were severely limited. The technology itself was still somewhat limiting: Three decades ago, LEDs were really only available for specific wavelengths - such as blue or red - as opposed to the white light used all over the world.

LEDs are solid-state devices based on semiconductor technology. In fact, a diode is a very simple semiconductor, and LEDs are literally semis that are specially designed to emit light.

Today there's a massive - and I mean massive - potential market. And Cree has a chance to crack it. Right now, only about 1% of all light sockets in the United States have LEDs installed in them.

Industry analysts estimate that people buy about 2 billion lightbulbs a year, or more than 5 million a day.

If you do the math, that roughly works out to $1 billion in annual lightbulb sales.

A Billion Here, a Billion There

I'm going to let you in on a secret that the rest of the investment world seems to have missed.

Most analysts use that billion-dollar figure to estimate total LED sales by the end of the decade.

But I think that forecast falls way short of the industry's potential.

Here's why. The forecast doesn't account for commercial buildings. Nor does it include sales of LEDs for cars, where the technology is really catching on. Ford Motor Co. (NYSE: F),Volkswagen AG, and Chrysler LLC, just to name a few, use them for headlamps, parking lights, and taillights.

And now this exciting technology is finding its way into billboards and streetlights.

Just as an example, the Bay Bridge linking the East Bay to San Francisco is adorned with an artistic necklace of lights that utilizes 25,000 LEDs.

Moreover, that $1 billion estimate includes the value of the incandescent bulbs that were once nearly ubiquitous - until the U.S. Congress banned them a few years back because they're so energy inefficient.

Indeed, an LED bulb can easily cost 20 times more than an incandescent one, which retailed for as little as $0.50. Over their lifetime, however - and this is crucial - LEDs are much cheaper to operate than either incandescent or high-output halogen bulbs.

To fully understand this, let's return to my personal, real-world example.

Hard to Believe

As I stood in my yard staring at the Japanese maple the other night, I engaged in a bit of mental arithmetic. The fixtures I bought cost twice as much as the halogen ones I replaced. But they included the LED lights and are guaranteed to last 50,000 hours - enough to burn 'round the clock ... for more than 2,000 days.

And I can personally attest to the LEDs' energy efficiency. Just to prove a point, I put on a pair of work gloves and touched a mini halogen bulb while it was on.

That bulb was so hot that it almost burned right through my glove. But I felt no heat at all from the LEDs - even after touching them with my bare hands.

You don't have to take my word for it. The U.S. Department of Energy estimates that switching to LED lighting over the next 20 years could save the nation some $250 billion in energy costs.

The conversion also would reduce electricity consumption for lighting by nearly one-half, the agency says.

For its part, Cree has carved out a commanding position in the growing LED sector. Over the past two years, the firm has refocused its operations to become more vertically integrated as a way to both lower overhead and expand into new markets.

Take its August 2011 purchase of Ruud Lighting for $520 million. The deal greatly enhanced Cree's position in the markets for streetlights, and lighting for hospitals, retail stores, and indoor commercial establishments.

At the same time, the company improved its research-and-development (R&D) operations and is limiting inventory to further squeeze costs.

Taken together, these moves have improved Cree's competitive advantage over challengers from China and other low-cost domestic importers.

All of Cree's efforts are paying off in the form of rising sales and surging profits.

And here's how it could pay off for you ...

Cree (Nasdaq: CREE): Packing a Punch

For its fiscal first quarter ended Sept. 29, Cree reported sales of $391 million, a 24% gain from the year-earlier period. Earnings per share (EPS) jumped 44% to $0.39.

Ordinarily, a report like that would ignite a nice little pop in the company's share price.

Instead, just the opposite happened.

Cree revised its guidance to show slightly lower growth for the current quarter as it spends more on marketing its line of LED bulbs for the retail market.

The stock got pounded back on Oct. 22, plunging nearly 17% in a single session.

Here's the thing: I believe the market grossly overreacted to the news.

In fact, I believe you right now have the chance to invest in the LED industry leader at the kind of discount that bakes a "margin of safety" into the share price.

Cree's shares currently trade at about $58 a share, giving the company a market cap of roughly $7 billion.

And the company is financially sound. It has an operating profit margin of 9% and is cash-rich. Last year, it brought in $125 million in free cash flow and has $1 billion in the bank with virtually no debt.

As we work together to pursue wealth at the Strategic Tech Investor, we usually target stocks to buy that have a good shot at doubling in price. But we also don't want to pass up big profit opportunities that are right in front of us.

In a recent Strategic Tech Investor column, I forecasted a Standard & Poor's 500 Index return of 15% in 2014. And after carefully studying Cree, we believe Cree could generate a return twice that of the broader market in the New Year.

In other words, we are predicting it could offer double the market's return - or a gain of 30%.

To generate that kind of gain, the stock would merely need to recover to its one-year closing high of $75.76, established back on Aug. 13.

Rebounding to that price doesn't take into account the huge earnings gains the company has reported of late - or the payoff on all that R&D money. If you factor that in, an upside of 45% or more over the next two to three years is entirely possible.

Cree represents one of those special situations that we've talked about in the past. By definition, stocks of this type do pose a bit more risk than average.

But gains of 30% to 45% make for a worthwhile potential payoff.

All of this ran through my mind as I finished my backyard lighting project, packed up my toolbox, and flipped the switch that caused our Japanese maple to blaze to life.

After decades of development - with LED technology having finally reached critical mass - the lighting capabilities that I've described to you today can achieve the same for your portfolio ... causing it to blaze to life.

In the meantime, we'll continue to ferret out these special profit opportunities for you.

[Editor's Note: Stocks aren't the only investment that Michael is watching. He's got his eye on a phenomenon that is white-hot right now: bitcoin. This "virtual currency" recently soared from $131 to $1,150 in just the past two months - a return of 778%. It's one heck of a story. And it's one that Michael understands better than anyone. Take a look here and you'll see what I mean.