Optical Networking Is AI's Most Overlooked Bottleneck. Here's Why This Nvidia-Backed Company Is the Stock to Own.

Many discussions about the artificial intelligence (AI) market revolve around Nvidia (NASDAQ: NVDA), the world's leading producer of data center GPUs. Those chips, which most of the world's top AI companies use, are still the best picks and shovels for the AI gold rush.

However, the AI market's growth is also generating strong tailwinds for optical networking companies, which manufacture optical transceivers and components that convert electronic data into light signals and transmit them through fiber-optic cables. Many data centers are now upgrading their older copper wires, which are too slow and generate too much heat to handle the latest cloud and AI applications, to faster fiber-optic components.

Image source: Getty Images.

That's why it wasn't surprising when Nvidia invested $2 billion in Coherent (NYSE: COHR), one of the world's largest photonics companies, in early March. Coherent's stock has rallied about 30% since that announcement, but it could still be worth buying as a long-term AI play.

How fast is Coherent growing?

Coherent, which was known as II-VI until it acquired the original Coherent and inherited its brand and ticker in 2022, generates most of its revenue from its optical business. That segment -- which was once a cyclical, slower-growth business -- became its core growth engine as the cloud and AI markets expanded. It also sells industrial lasers and specialty chips, but those smaller businesses don't generate nearly as much growth as its optical networking division.

In fiscal 2025 (which ended last June), Coherent's revenue rose 23%. From fiscal 2025 to fiscal 2028, analysts expect its revenue to grow at a 31% CAGR. They also expect its EPS to turn positive in fiscal 2026 and grow at a 52% CAGR over the following two years. Its rising sales of ultra-fast 800G, 1.6T, and next-generation 3.2T optical products to data centers should drive most of that growth. It's also firmly backed by Nvidia, which works with the company to connect millions of its GPUs across "AI factories", and it was recently granted $50 million in funding under the CHIPS and Science Act to expand its manufacturing plant in Sherman, Texas.

But does Coherent deserve its premium valuation?

Coherent's stock isn't cheap at 65 times next year's earnings. However, it's transforming from a cyclical networking play to a high-growth AI play -- and it could continue to command a premium valuation for the foreseeable future. So if you expect the AI market to keep expanding over the next decade, it might be smart to invest in Coherent before it attracts even more attention.

Leo Sun has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Coherent and Nvidia. The Motley Fool has a disclosure policy.