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The obscure tech stock that’s nearly quadrupled this year – and could keep rising

  • Shares of Applied Optoelectronics have enjoyed a huge rally in 2017.
  • Some analysts see continued upside for the fiber-optics company.
  • On the other hand, several factors make it a risky purchase.

The name "Applied Optoelectronics" may not immediately grab investors' attention, but among momentum-motivated traders, the stock's performance ought to turn plenty of heads.

With a rise of 279 percent this year, Applied Optoelectronics is easily the best performing stock in the broad S&P 1500 index, which is composed of all the stocks in the S&P 500 as well as small- and mid-caps. The fiber-optic networking products company is also the index's best performer over the past year, during the course of which it has risen 649 percent.

Actually, comparing AOI to the other stocks in that index is perhaps a bit unfair, since it was not in the S&P 1,500 for most of that time. AOI was only added to the small-cap S&P 600 in April, shortly after the company's market value first broke above $1 billion in March.

For Raymond James' Simon Leopold — who has maintained a "strong buy" rating on the stock since his firm helped lead AOI's 2013 initial public offering — the recent increase in investor attention has been notable.

"It's been under the radar for quite a few people," Leopold told CNBC's "Trading Nation" on Thursday. "I think when the market cap hit about $1 billion, that was big enough that it landed on a lot more screens than it had when it was $200 million market cap."

AOI makes fiber-optic components and equipment that are used in a variety of contexts, though data center products make up the lion's share of their revenue. It is also a beneficiary of Amazon's success. The company's first-quarter earnings report disclosed that sales to Amazon represented 54.6 percent of the company's revenue in 2016; Microsoft contributed 18.3 percent.

AOI has focused on a business model "that's driven by high volume, and they're doing this at a time when the web-scale operators like Amazon are seeking more and more capacity at lower and lower prices," Leopold said.

He doesn't see that trend turning around anytime soon. Sticking with his strong buy rating, Leopold recently upped his price target by $7 to $107 on the now-$88.80 stock. It was his fifth target increase this year, and he says it's not likely to be his last.

The $107 target "is based on really, I think, a very conservative trajectory," Leopold said. He's forecasting a drop in the company's profitability but commented that "if the company continues to even just maintain gross margin … we see upside to that $107 model target."

In addition, the stock is trading at a reasonable valuation of 17.5 times expected earnings for this year.

Leopold's target is currently the highest on Wall Street, but seven of the nine analysts who cover the stock currently have buy ratings, according to FactSet data.

The Street's sole bear, Hamed Khorsand of BWS Financial, continues to poke holes in the story, arguing on Thursday that the company will have trouble transitioning its focus to a faster transceiver. Khorsand has a striking $25 price target on Applied Optoelectronics.

To be sure, those who opt to buy the volatile small-cap stock should not necessarily expect smooth sailing. It has just enjoyed two-straight years of 45 percent-plus sales growth amid growing profit margins, a trend that may or may not be sustainable. And its heavy reliance on a single customer adds an extra layer of risk.

While pointing out that its moderate valuation makes it potentially less risky than some "traditional momentum stories," Leopold said he wanted to make one thing about AOI "absolutely clear": "This is not a stock that's appropriate for widows and orphans."

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Brian Sullivan is co-anchor of CNBC's "Power Lunch" (M-F,1PM-3PM ET), one of the network's longest running programs, as well as the host of the daily investing program "Trading Nation." He is also a frequent guest on MSNBC's "Morning Joe" and other NBC properties.

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