Yesterday I received an interesting question from a friend of mine who has been thinking about getting involved in Research in Motion. Why? The Canadian company has been crushed over and over and we have been among those who have been very critical of the company for months now. That being said, the stock has been getting killed over the past few months and it’s been even more intense in the past week after Research in Motion announced dismal results. Its stock closed out yesterday’s action at $25.89 because of its earnings restatement among other things. The company announced it expected to make a profit per share of between $5.25-$6.00 this year.
P/E Of 4?
How can a profitable company such as Research in Motion be trading at a P/E of 4? You might think that there is something wrong with your math, and go verify that data at a site such as Google finance. They will give you the same number– a P/E ratio of 4.11. It’s an incredible bargain right? What kind of stock trades at a P/E of 4?
Wait A Second… P/E Is Not Perfect
There are no perfect ways to evaluate a stock and while I’m a big fan of using the P/E ratio, it’s not perfect. In this case, most of the market anticipates that Research in Motion’s revenues and profits will continue to decline which makes it very difficult to use the P/E ratio. Why? Here are a few scenarios:
Current Price: $26
Expected Earnings 2011: $6.00
P/E ratio: 4.33
Expected Earnings 2012: $4.00
P/E ratio: 6.50
Expected Earnings 2013: $2.00
P/E ratio: 13.00
Now let me ask the question differently. I know that you are willing to buy RIMM at a P/E of 4.33 right now. But would you be willing to buy a company that has declining profits and a P/E of 13? Probably not right? That could very well be RIMM 2 years from now and if the majority of the analysts expect it to be the case, they will not even buy it at its current P/E of 4.33.
RIMM Might Be A Bargain
There are plenty of reasons why RIMM could be a good purchase. The stock is cheap, it might be oversold, it could be acquired, it still has a shot at making a great phone, it’s been knocked down in the past and always came back stronger, etc. All of those could be very valid reasons to buy the stock today. Seeing a P/E ratio of 4.11 isn’t however. In some cases, such as this one, P/E only tells a small part of the story.