Why The Market Is Still Wrong About RIM

Looking at the chart below, you could probably conclude at least one of two things: either Research in Motion (RIMM) is in complete disarray, or the market’s irrational exuberance of late 2008 is currently being complemented by a period of investor apathy.

Click to enlarge images

Source: Bloomberg

I would argue that there is truth to both theories, but in the end, RIM is a solid buy at current market prices because of the usually cited and sometimes ignored reasons, mainly:

• Solid earnings
• New QNX software coming to market
• Smartphone of choice for the business professional
• Smartphone market is growing
• Potential takeover target

But that is not enough for most investors. For several years now, there has existed an inverse relationship between the street’s valuation of RIM and reality. Since August 2008, RIM’s stock price has crashed, recovered somewhat, traded sideways, and crashed again – with seemingly no end in sight. The reality has been an altogether different matter, however, as RIM’s earnings have grown every year for the past 10 years. On a cash basis, the story is similar as there has been steady growth in the firm’s annual cash flow over that same period. RIM’s financial statements are so clean and easy to understand that it does not require a sophisticated investor to read them. Every dollar of revenue follows straight through to the bottom line. In the fiscal year 2011, RIM posted its biggest year to date with earnings of $3.4 billion, or $6.36 per share. Yet even as the company continued to perform and grow, there appeared to be a disconnect between those results and the stock price.

Source: Research in Motion

So what’s the problem? The Smartphone market has exploded, which in turn has attracted new entrants to the industry. Apple’s (AAPL) iphone has proven to be an exceptional product and has turned that company into the world’s largest. New Android devices are also becoming extremely popular and RIM is being squeezed. Revenue from last quarter (second quarter of fiscal 2012) [see transcript] was $4.2 billion, down 17% from the quarter previous and 9% from the same quarter in 2010. The reason for this decrease is twofold. First, sales for RIM’s hardware devices significantly fell off pace; and second, the hardware devices that were sold tended to be lower end models.

There is a saying in sports that you’re only as good as your last game. For RIM, it would appear you’re only as good as your last fiscal quarter. The company has not been able to match the growth it enjoyed during the mid 2000s, which has resulted in missed targets. The demise of RIM, however, started well before RIM’s recent faltering when the company was performing admirably. No investor wants to own the next Nokia (NOK), and many are quick to draw comparisons between the two companies. But RIM is not Nokia, and it is not the growth stock it once was. But that does not mean it’s not worth owning at current market prices.

RIM will continue to generate large amounts of cash into the foreseeable future. Even if the company continues to lose market share to the iPhone and other Android devices, the size of the market is growing. RIM is currently trading at about 4 times earnings which is unprecedented in the company's history. There is value in this company, and the reasons noted above for owning RIM are all true. The market was wrong when it valued RIM at $150 per share in June of 2008, and it is wrong now valuing it at $22 per share.

Disclosure: I am long RIMM.