Smartphone Valuations - Which 4 Stocks Should You Consider Buying?

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

There are many smartphone firms trading at very different valuation multiples. Do differences in breaking news and strategies justify these differences? In this article, I will specifically focus on four firms: Nokia (NYSE: NOK)Research In Motion (NASDAQ: BBRY)Apple (NASDAQ: AAPL), and Google (NASDAQ: GOOG). I chose these four firms because I believe they provide the clearest examples of how different valuations in this space can be, which will make it easier for investors to pick out the winning investment opportunities from the losers.

By considering valuation and subjective factors at the same time, we can begin to distinguish which smartphone companies are defensible investments. Google, for example, looks less attractive than Apple, given that its risk-averaging compatibility strategy is its high valuations. On an earnings multiple basis it is almost twice as expensive as Apple. Examples of subjective factors include marketing problems, power outages, and device connection/incompatibility issues.

Valuation Considerations

Consider these four smartphone contenders, which are available to U.S. retail investors:

Ticker

Company

P/E

P/S

P/B

P/FCF

EPS Growth Next 5 Years

NOK

Nokia

NA

0.25

1.01

NA

4.20%

RIMM

Research In Motion

NA

0.31

0.49

9.37

5.00%

AAPL

Apple

12.29

3.26

4.31

12.32

20.86%

GOOG

Google

20.86

4.6

3.22

17.27

15.70%

It will become clear that Nokia and Research In Motion are cheap based on valuation because they are risky. I believe Apple is cheap based on valuation for no good reason, and Google is too pricey based on valuation, though I believe it has a great strategy.

Smartphone Security Approval

Just as the new Blackberry 10 Operating System is scheduled to debut, Research In Motion received security certification FIPS 140-2 from the United States' National Institute of Standards and Technology. This is the first time that this certification has been received by Research In Motion before commercial introduction.

The operating system is expected to be released in the first quarter of 2013. Predictions indicate that the company will struggle to attract customers, even as more than 50 carriers have begun testing the smartphone. The company aims to gain from its biggest and staunchest customers, more than 1 million US governmental agencies, as market shares among US customers decrease due to competition. The certification is expected to generate confidence in its biggest customers.

This news is especially welcome since the Defense Department had announced that they would hire a contractor to build a system to manage and secure Apple and Android devices, a big blow to Research In Motion. With this contract, government employees would be able to work from their own devices after installing security layers in their software. While this new setup allows the Defense Department to be flexible on what type of device their employees use, security is still non-negotiable. This development helps substantiate Research In Motion's ability to compete for government contracts against Google and Apple.

Google seems to be a better and better investment as its mobile device peers continue to struggle with product-specific problems. Should investors go with Google's many-device Android platform strategy, or stick it out with a competitor?

Strategy Check

The same strategy can reduce risk for firms just as it does for investors. There are many other mobile devices that run Google's Android operating system. This diminishes the impact of glitches in service or hardware versions that can shut down a less diversified platforms.

One embarrassing example of a glitch came from a version of the iPhone 5 that cannot connect to the 4G networks of several European carriers. The new 4G networks, which are based on long term evolution technology or "LTE" technology allows users to watch videos, play music, and perform other tasks at speeds that exceed those 3G. This iPhone 5 incompatibility issue forced many European consumers to choose between Samsung Galaxy phones that are compatible with 4G networks and Apple iPhones with 3G service.

Apple has worked with telecom providers to make up for the European 4G compatibility issue to offer promotions and future upgrades to customers. Hopefully these fixes will mitigate this compatibility issue.

Europe also suffered issues with Research In Motion's BlackBerry when its customers found that their service was temporarily disrupted when Apple launched its new iPhone. This disruption is reminiscent of a BlackBerry disruption that happened when Apple debuted its iPhone 4S. This fiasco prompted a public video apology by the company's chief executive officer.

Fortunately, this latest outage has been resolved. BlackBerry users in the Middle East, Africa, and Europe lost both email and internet access. It is estimated that more than 78 million BlackBerry subscribers could have been affected by this latest outage, although it lasted less than three hours.

Marketing problems can also sour consumer attitudes regarding specific product lines. Nokia made news recently when it produced promotional material consisting of pictures and videos not originally taken by the mobile phone it promoted. These were looked down upon as misleading potential customers about its new Nokia Lumia 920 smartphone. This mistake has become a serious problem for the Nokia because it is betting on the Lumina 820 and Lumina 920 to reverse its loss of market share.

Clearly, there are many sources of risk for any particular product line. Through its cross-platform diversification, Google is able to average this out.

Conclusion

The primary reason why Google's stock is not a buy given its risk-averaging compatibility strategy is its high valuations. On a earnings multiple basis it is almost twice as expensive as Apple. Apple, as it turns out, is a compelling buy opportunity at current prices. Its 3.26 price-to-sales ratio is high, but still lower than Google's ratio.

Nokia and Research In Motion are much more speculative. Neither firm has turned a profit over the last twelve months. Both are trading at low price-to-book multiples. Their multiples should be thought of as much cheaper than the S&P 500, average especially since the price-to-book multiple ignores internally-developed intellectual property, including patents, brands, and trademarks. If the economic value of these assets were recorded on the balance sheet, the firm's price-to-book ratio would be substantially lower. Of these two firms, investors should consider buying shares of Research In Motion because it is cheaper than Nokia and has been able to stay cashflow positive.


BillEdson11 has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple and Google. Motley Fool newsletter services recommend Apple and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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