(MONEY Magazine) – So you want to play in the scorching-hot optical networking space? Here's a suggestion from Merrill Lynch's crew: "Tighten up your seat belts, keep a paper bag handy and hang on for the ride." That's wise advice, given the sector's explosive rise and stratospheric valuations. Consider Corvis, which went public on July 28 at $36 a share and hit $85 by day's end.

That gave it a staggering $29 billion market value--about the same as Sprint's. The catch? Corvis, which invented a switch that helps telecom carriers direct data over fiber-optic networks, hasn't recorded a single dollar of revenue. Zilch. Zero. Nada. All it has is a high-profile ceo, David Huber (the optics whiz who founded Ciena), prominent backers such as Kleiner Perkins Caufield & Byers, and promises from three carriers to buy $550 million worth of its gear. "Right now you could have an ipo for a company called 'Optical Bag of Donuts' and it would go out big," Cisco's optics chief Carl Russo has reportedly joked.

Corvis is just the latest symptom of the craze for optical stocks. Shares in optical-parts maker JDS Uniphase have quintupled in the past year. Nortel, the leader in optical networking systems, has soared 265% in that time, and Corning, which sells optical fiber and components, is up 365%.

Is this euphoria just a repeat of the mania for Internet stocks two years ago? Some formidable investors scoff at the comparison. "In the short term, the stocks may look similar, but this is a business with lots of revenues and good profits," argues Chip Morris of T. Rowe Price Science & Technology. He's staked 11% of his $15 billion fund on suppliers of gear that enables networks to carry voice, data and video traffic on light waves. As he sees it, "We're in the early days of a multidecade secular shift" from electronics-based communications networks to optical networks. Telecom consultant RHK Inc. figures that the market for optical equipment can grow 75% a year, fueled by demand for data-hungry applications like streaming video and Internet telephony.

No wonder all the big boys are jockeying for position in this burgeoning business. Cisco spent $11 billion in the past year to buy seven fledgling optical firms. JDS Uniphase, which sells components for optical systems made by Nortel and others, is also expanding aggressively. It's buying SDL, an optical-parts maker, for $40 billion--steep for a firm with sales of only $290 million. Lucent is also intensifying its focus on optics: It plans to spin off its optical-parts business, and it's streamlining its optical-networking division.

But are optical stocks still good investments? Well, there's no question that a lot of these firms are growing breathtakingly fast. In its latest quarter, JDS Uniphase saw profits surge to $114 million--up 178%, vs. the same quarter in '99. Still, I think these stocks have gotten way ahead of themselves and that valuations have become dangerously inflated. JDS now trades at 210 times this year's projected earnings. Cisco's P/E is 108, Nortel's is 117 and Ciena's is 224.

Max Schuetz, a well-regarded analyst with Thomas Weisel Partners, counters that valuations are "still in a reasonable realm" given the industry's potential growth. This year, he says, $220 billion will be spent on telecom infrastructure, only 10% of it on optical equipment. In five years, he expects telecom spending to exceed $400 billion, with half of it going to buy optical gear.

But even Schuetz worries that investors are getting carried away. He charges that many early-stage optics companies are being valued as if they already dominate the business. For proof, look no further than Corvis.

My worry: Demand for optical equipment may not be as robust as bullish investors would like to believe. Tom Nolles, president of industry consultancy cimi, points out that telecom carriers--including giants like WorldCom and at&t--are struggling to make money off of Internet services. As a result, he says, their purchases of optical equipment could slow significantly over the next year or so. That would hurt both systems manufacturers like Nortel and Lucent and component makers like JDS Uniphase and Corning. Nolles predicts that the optics boom will end in a "big bust," just as dotcom mania did. Investors' expectations are so high, he warns, that they "just can't be realized."