Research In Motion: A Smart Call, Long Term

Research In Motion Ltd. (RIMM) reported earnings Thursday. Apparently some analysts were disappointed with a 37% increase in revenues and strong earnings. Common sense would dictate that the stock market’s reaction to Research In Motion’s actually solid quarter is extreme. First of all, it’s irrational to believe that the intrinsic value of an established company such as Research In Motion, could possibly change by 15% or more in a single day.

Someone needs to be the voice of reason, and we are happy to be it. The market was either wrong Thursday, or it’s wrong Friday. This unequivocally establishes that the market is sometimes wrong. Frankly, we believe Friday was one of those times, and Thursday’s price for Research In Motion is the more accurate one. Stock price volatility can be a very unreliable indicator of value. Can everyone remember “irrational exuberance?”

Fundamentals
Before I launch into a heated diatribe, let’s look at what the fundamentals of Research In Motion, Ltd. are in comparison to some of its major rivals. I will use our EDMP (Earnings Determine Market Price) Fundamentals-at-a-Glance™ research tool to cast a light of reason on the subject. Earnings power, in contrast to price volatility, can be relied upon long term.

In Figure 1 we show Research In Motion’s compounded earnings growth of 75.9% since calendar year 2004 correlated to stock price. The performance results table for the period through Thursday’s close is below the graph. Note that Research In Motion has no debt, and earnings are forecast to grow by 19-20% in 2010. Thursday’s so-called “miss” doesn’t change that forecast. So, after Friday’s price drop to the low 70’s, Research In Motion is only being capitalized at a forward PE ratio of approximately 15.

Fig. 1. RIMM 7yr EPS & Price Performance

In Figure 2 we present Apple Inc. (AAPL). Here we find almost identical fundamentals to Research In Motion . The biggest difference is that Apple Inc. trades at a blended PE ratio of 31.6 (see Figure 2) and a forward PE ratio of 27. Even though Apple is forecast to grow earnings at a slightly slower rate than Research In Motion, the market inexplicably is capitalizing Apple’s earnings at twice the rate of Research In Motion. This makes no sense to us. After all, a dollar’s worth of earnings is a dollar’s worth of earnings. I doubt a store would sell me twice as much merchandise for a dollar’s worth of Apple’s earnings than they would for a dollar’s worth of Research In Motion’s.

Fig. 2. AAPL 7yr EPS & Price Performance

In Figure 3 we show Palm, Inc. (PALM) The graph speaks for itself, there really is no comparison based on fundamentals.

Fig. 3. PALM 7yr EPS & Price Performance

Figure 4 charts Nokia Corp. Although Nokia (NOK) is a solid company and pays an attractive dividend, it hardly stacks up based on earnings growth.

Fig. 4. NOK 7yr EPS & Price Performance

Growth Prospects
It’s almost universally accepted that smartphone technologies are most certainly a growth market. I have read estimates that the PDA market could be north of a quarter of a trillion dollars by 2015. Most of that growth forecast is attributable to a growing preference to feature rich smartphones over ordinary mobile phones. The terms PDA and smartphone are rapidly becoming synonymous. Contrary to what some analysts are alluding, smartphones are the fastest growing segment in mobile and the most resistant to declining ASP’s, though not totally immune.

The opportunity for Research In Motion in particular is huge. True to their name, Research In Motion continues to invest heavily in research and development. Not content to being the leader in sales to big business, they are creating a strong pipeline of feature rich offerings to appeal to consumers and small to mid size businesses as well. It seems odd to us that they are being penalized for entering this large and profitable market.

We agree that moving down market to consumers presents the risk of margin shrinkage. However, margins should remain high enough to support earnings growth of 20% or better for years to come. This is certainly a far cry from the 70% plus historical earnings growth they have achieved to date, but it does support today’s forward PE ratio of 15 or less. Historically, Research In Motion’s PE ratio has exceeded 45.

We do believe that Research In Motion’s superior technology and strong commitment to research and development will allow them to continue to dominate the enterprise segment. Moving down market to consumers will most likely impact margins. However, this market is huge and margins are high enough. Furthermore, we believe it’s in the best interest of all competitors to keep them at least healthy. Yes, the segment is attracting a lot of competition; however, we believe the smartphone opportunity is big enough to keep them all on a healthy diet of rich profits for years to come.

Conclusion
Research In Motion remains, in our opinion, a healthy and capable competitor. Current price reaction we believe is overdone and represents a great entry point for the prudent investor with a long-term horizon. You can read the earnings call transcript yourselves so there is no reason for me to regurgitate it here. The point is, Research In Motion had a good quarter. They are not bleeding red ink or facing oblivion. In fact, the opposite is true. Over the next five years, we believe they should be able to continue to grow earnings at 15% or better. Investing at today’s low valuation, presents an opportunity to buy those future earnings inexpensively.

Regarding the smartphone space at current valuations, we like Research In Motion, Ltd. the best - long term. Apple Inc. would be our second favorite if its valuation were more attractive. Palm is an interesting takeover speculation but doesn’t meet our criteria as an investment. Nokia, our third choice, is a good conservative company with a nice dividend yield that we believe lacks the growth potential of Apple or Research In Motion. Google should participate as well, but the company is too big for smartphones to make a major difference. There are many other competitors, but once again, we believe the market is big enough for them all.

Disclosure: Long RIMM, GOOG at the time of writing.

Comments

[bluesky123:]

I have not previously owned RIMM but bought on Friday. I want some part of my portfolio hedged against USD weakness and benefiting from global sales. RIMM has presence in almost 100 countries and it is a stock I can buy on a US stock exchange (ie without having to buy overseas stocks and deal with the FX hassle). Smartphones have barely started. Most people even in the US that I know still don't have one. The emerging markets potential is also huge. I see this stock going to $100.

Sep 27 04:42 AM

[Roger Knights:]

The article is probably using Apple's GAAP earnings, which make its P/E ratio look way too high. As for RIMM's competitiveness going forward, here's a devastating InfoWorld review of RIMM's Blackberry, at www.infoworld.com/d/mo...

"Deathmatch: BlackBerry versus iPhone: It’s time for us to bury the BlackBerry and move on to modern mobile -- even for e-mail

"By Galen Gruman / InfoWorld / MAY 26, 2009"

It concludes, "For everyone else, the BlackBerry is yesterday's mobile messenger, way past its prime and heading toward retirement. The iPhone is light-years ahead of the BlackBerry on almost every count."

Sep 27 05:21 AM

[Tom B:]

You're betting money on "buggy whips", long term?

Sep 27 10:07 AM

[martyg:]

comparing aapl with rimm is like comparing apples and blackberries.

rimm is still a one trick pony. cell phones.

aapl has a broad portfolio of products to fall back on with new ideas coming forward on a regular basis. rimm has to wait for aapl to come up with a new idea and then try to integrate it into their system.

Sep 27 10:58 AM

[GSlusher:]

The author doesn't say whether he's using GAAP or non-GAAP earnings for Apple. That could be because he doesn't know that there is a difference. If that is so, his analysis is useless. This is not "new" nor hidden, nor even very complicated.

Sep 27 02:35 PM

[Cali-arch:]

Apple and RIMM can't be compared as apples to apples, I agree. There is plenty of room in the smartphone space for multiple winners, and will inlclude apple, nokia, google, windows, rimm, as well as others down the road. The market itself is growing @ 20-30% a year for smartphones, and rimm should rise with that tide.

Is apple making better products with a real Eco system in place? Yes....but not everyone wants an iPhone. Nokia will be the big loser here over the next few quarters...not rimm.

I think goog, aapl, and rimm should be a part of any portfolio!

Sep 27 02:51 PM

[PharmBoy:]

RIMM is a screaming buy here. When a premium product at the store goes on sale, do you turn your noses up at the marked-down price? On the contrary. Most rational people would back up the shopping cart. If your investing horizon is limited to the short-term, RIMM is quite possibly not the best smartphone candidate out there (hats off to AAPL on that one), but if you think that this arena has huge potential and are willing to look out several years, one will be able to look back and see what an opportunity it was to establish a partial position in this stock. Buy yourself some deep, long-dated ITM puts in case the thesis doesn't pan out. But to think that RIMM won't be higher by at least two dozen points 12-24 months out from now, that would be flat out boinkers.

Sep 27 04:15 PM

[relayer75:]

Also, don't forget to subtract AAPL's $31 billion (or possibly more now) in cash from its market cap, if you want the "p" in the p/e ratio to reflect reality.

I second what others have written regarding GAAP vs. non-GAAP for AAPL. The elimination of the FASB rule regarding subscription accounting for the iPhone is going to have a tremendous effect on AAPL's GAAP earnings, and then analysts like the author will (hopefully) finally stop publishing articles that claim that AAPL's p/e is north of 30.

This is not to slam RIMM; I agree with the premise that the latest "miss" has created a good buying opportunity. The world is big enough for both RIMM and AAPL to continue to succeed. Maybe not PALM, though.

Sep 28 09:33 AM

[Chuck Carne...:]

I want to thank everyone for commenting on this article. I also want to clarify a few things. This was not intended to compare AAPL vs Rimm. It was written to express what we felt was an absurd overreaction to Rimm's good quarter,and point out that the "smartphone" market was large and growing rapidly. Yes, our research tool only pulls GAAP numbers. I understand the subscription accounting dilemma for AAPL. However, this only has had real relevance since the i-phone has become approx. 40% of AAPL's rev. and their major growth driver. Prior to that the revenue amortization issue had little impact on GAAP numbers. I concur that today it does and the accounting change will be more reflective. However, we still believe Rimm the better buy based on growth and value.

AAPL's other products only dilute their opportunity for growth relative to the smartphone opportunity,in our opinion. So,yes RIMM is more of a pure play. Also, they are hardly a "buggywhip" and the Blackberry holds many advantages over the i-phone ,and vice versa. Our point, one "size" doesn't fit all, and as stated in the article ,there is room for them all. We simply feel this market is a great place to look for long term growth. Also, we believe the evolution of the PDA/smartphone is just starting.

One final comment. There is and has been a lot of abuse with non-GAAP accounting shenanigans by corporations,especially in tech. In AAPL's case it may truly be appropriate,but in many others it has not. We believe that earnings do determine market price in the long run. However,they have to be real earnings,not make believe. Both AAPL and RIMM have good balance sheets with little debt and strong cash flows. To repeat the article, we like both AAPL and RIMM,we hold RIMM and plan to add based on valuation.

Thanks again for your comments,

Chuck

Sep 28 10:32 AM