Friday, April 22, 2011

Research in Motion: Contrarian Investment or Trap?

Here's a recent Barron's article on Research in Motion (RIMM) and its troubles.

Research in Motion clearly exists within a very difficult to understand competitive landscape, the rapidly changing smartphone world, but eventually what seems like a low price relative to prospects makes something like this interesting.

It's certainly not the kind of wide moat business in a stable industry that I usually like to invest in. So I won't buy it.*

The extremely low valuations across the big cap tech landscape was hard to imagine a decade ago. As technology companies, each has real competitive threats (some more than others) and other short-to-intermediate term difficulties. Yet, it's hard to understand why many of them seem to be selling at more or less a discount to a conservative estimate of intrinsic value.

Some of the big cap tech stocks now sell at enterprise value (enterprise value = market cap - net cash) to earnings in the low teens while others sell at single digit multiples.

These businesses, to varying degrees, generate more than respectable returns on capital. It's the durability of those economics that is always a difficult question to answer with tech companies. That's why, unless there is a huge discount to intrinsic value, for me it's preferable to avoid them.

Having said that, I could buy the idea that one or two of them are going to get into trouble but...all of them? It's tough to come up with a plausible scenario where that happens. The basic arithmetic of these valuations does not seem to make sense given likely future outcomes. A business selling at a single digit multiple (or normalized earnings) can generate healthy returns for owners even with no growth prospects if management is a good steward of capital. Unfortunately, too many are not. Still, as I said in this previous post, if the external threats are financially catastrophic (i.e. many newspapers in recent years) then almost no price to earnings multiple is low enough.

The current situation with tech stocks appears to be the exact opposite of a decade ago where people were paying nonsensical valuations for wildly optimistic future expectations.


* No position in RIMM. I don't yet have a good feel for the risks involved in a very challenging business with unpredictable competition. So I remain uncomfortable with RIM's competitive threats.

I do have long positions in some other large cap tech stocks though each is small in size relative to the portfolio. The reason they are not larger positions? Because, in general, technology businesses reside within fast changing, unpredictable competitive landscapes. It's just that these businesses over the past couple of years sold at price levels in the market that provided a very large margin of safety in my view. So until the margin of safety shrinks I'm willing to have some limited exposure. Unlike shares in some of my favorite businesses (i.e. those in Stocks to Watch bought at the right price) these tech stocks are mostly NOT long-term investments.
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