RIM: Classic Example Of Valuation Fallacies

| About: BlackBerry Ltd. (BBRY)

Research In Motion Limited (RIMM) held a nightmarish conference call to announce its Q4 2012 results and with it much more bad news for the firm and investors. Let's bullet them:

  • Missed EPS by 1 cent and revenue by $350 million
  • Retirement of the CTO Mr. David Yach
  • Resignation of board director Mr. Jim Balsillie
  • Gloomy outlook
  • Failure to issue future earnings guidance

Phew! It's hard to recall an earnings call filled with more bad news than this one. And while reading the results and also looking at the financials, we thought RIMM would make a good subject on why "cheap" does not equal value. Also this article presents a few commonly used valuation metrics and uses RIMM as an example as to why those metrics can be misleading. We hope this gives investors the valuable takeaway that looking at one or two financial metrics alone can be dangerous. Let's get into the details.

Book-Value per share: This is tied to the debt factor addressed below. Famous investors like Peter Lynch advocate buying companies trading at less than their book value. Book value is the accounting value per share. This metric comes to use when we think of a company liquidating all its assets and distributing the proceeds to the shareholders. But rarely do a company's assets get sold at the accounting value. In our opinion book value can at best be treated as a secondary indicator, behind earnings. Just because RIMM's price per share is around $13 while its book value is almost $20 doesn't mean RIMM is a buy.

Price to Earnings: Ha, the first factor every new investor looks at. This can be the most misleading metric if one is not careful. Advocates of PE ratio advise to look at the PE ratio of the competitors and if your stock's PE is lower than the average, then you found a potential winner. The point forgotten here is that the price you pay is for the company's future earning power. Not the past. RIMM's current PE of 3 sounds dirt cheap on paper but the fact that it is losing market share continuously to more powerful players like Apple (NASDAQ:AAPL), Android (NASDAQ:GOOG), and Windows (NASDAQ:MSFT) is much more important than the PE ratio.

Zero Debt: For the RIMM bulls, the one area where RIMM appears better on paper compared to companies like Google, Amazon (NASDAQ:AMZN), and Philip Morris (NYSE:PM) is the debt factor. RIMM has zero debt. Highly leveraged companies (high debt) are usually more risky than debt free companies. However, a highly leveraged company like Philip Morris with meaningful earnings is a better bet than a company with zero debt and low earnings power.

Low End of 52 Week Range: A lot of investors have the habit of "bottom fishing." They look for beaten down stocks and pick ones which are trading near the low end of their 52 week range. This approach is understandable when you are talking about a cyclical stock like Freeport-McMoRan (NYSE:FCX), where if you get in at the right time of the cycle, you can quickly make profits. It also applies to companies with steady earnings power that are encountering temporary setbacks. We presented the case of PepsiCo (NYSE:PEP) in an earlier article and how the recent concerns over the firm present a good buying opportunity. However, that doesn't hold true for a company like RIMM where the fundamentals are shaky and the company has been going down day by day. Traders and technical investors (like chartists) would rather buy a stock trading near its high than one trading near its lows.

Conclusion: We acknowledge that there were a few positives out of the conference call. The new CEO Mr. Thorsten Heins (a stylish name by the way) seems to understand the issues and hinted at partnerships/buy. However, the intention of this article is not to focus on the positives or negatives of RIMM but rather highlight how some of the key valuation metrics can be misleading.

Disclosure: I am long AAPL, PM, short RIMM.