Is There Any Value in These Beat Down Companies?

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

Unusual trends and valuations are nothing odd in the market. Every now and then a stock can trade at levels that cannot be explained, either to high or low levels. Stocks can post large gains as they bounce off the bottom and give the illusion of a recovering company. However, these unusual trades do not mean that a company is a buy. And just because it has multi-year losses doesn’t mean that it will continue to trade higher once bouncing off the bottom. In other words, short-term performance doesn’t make a stock a long-term buy. To better explain I am looking at four stocks that have recently traded higher, but are not ready to trade higher over the long-term.

Best Buy (NYSE: BBY)

Shares of Best Buy increased 9% on Wednesday and Thursday, as the stock bounced off multi-year lows and responded to speculation and rumors. Despite its gains the stock still has lost 60% over the last five years, and there is no reason to believe that either revenue or margins will begin to recover in the near future. Instead, the stock has traded higher because of a rumor, actually a renewed rumor, that founder Richard Schulze and at least four private equity firms are in the early stages of potentially acquiring the company for $11 billion. Obviously, if the rumor is true then Best Buy is presenting very large upside, however investors must consider this “rumor” will never materialize and cannot base an investment decision on the “early stages” of a potential acquisition.

This isn’t the first time this rumor has driven shares of the company higher, nor will it probably be the last. And although it is very possible this acquisition occurs, it will most likely be several months, maybe even a year, before it happens. In the meantime, shares of the company may fall further due to declining fundamentals. Therefore, in my opinion, Best Buy is far from being a “buy” based on the potential acquisition alone. However, the company recently hired former Expedia and Skype executive Scott Durchslag to improve its online store. One of the primary reasons for the company’s fall has been its loss of market share to companies such as Amazon and Ebay. Best Buy has become a store where consumers can test products, but then buy elsewhere. Therefore, the online store will be crucial to the future of this company. If the online store can be “reinvented” and made more efficient, then perhaps Best Buy is presenting value. But until this occurs, I suggest shorting the stock on rumors.

Research in Motion (NASDAQ: BBRY)

Since the iPhone 5 launch Apple has traded flat, even dipping below its prelaunch price. Research in Motion has actually traded higher since the iPhone 5 launch, by more than 10%. In particular, its gains have occurred since September 24, a gain of 30%, after the company beat earnings expectations, announced its new Blackberry 10 operating system, and announced an increase in the number of subscribers. All of these announcements are great, but keep in mind, the company is still burning cash, and most likely wouldn’t have seen a decent quarter if not for consumers not buying the iPhone 4S. In terms of price/sales the company is cheap, however it’s losing market share, and I personally find it odd that the stock would rise after the iPhone 5 launch. I think it makes more sense that the iPhone 5 launch would have caused a 30% decline in shares of RIMM, especially because of the demand. Therefore, I see nothing but trouble for RIMM investors, and would short this stock along with Best Buy. The company’s operating system has simply become obsolete, with a fraction of the apps found on Android or the iOS. I think the company needs to stop releasing new Blackberrys and go back to the drawing board to create something unique and innovating. Until then, the company can continue to operate under the same insane assumption, which is using the same strategy while expecting a different result.

Nokia (NYSE: NOK)

My opinions regarding Nokia are almost exactly that of RIMM, except I see an easier way out for Research in Motion. Nokia is a company that is on a death spiral, out of control with fundamentals that are declining at an incredible rate. The company continues to downsize and fire employees, yet margins continue to decline as the company is far from achieving profitability. To fully understand the severity of Nokia’s decline just look at its operating cash flow: In 2010 the company had $4.7 billion in operating cash flow, in 2011 it had $1.1 billion, but during the last nine months it has slipped to negative $1.078 billion, and keep in mind the company has been cutting costs as quickly as possible. This decline is unprecedented, I can imagine the company’s executives sitting in a big corner office, crossing their fingers, and praying that the new Windows phone creates some level of interest. To me, there is too much “hope” and not enough “results” occurring at this company. Therefore I don’t understand its 55% gain over the last two and a half months. The good news is that Nokia does have a large cash position and more than $8 billion in retained earnings, so its chances of survival are quite high. However, it must stop the bleeding and figure out a way to operate with positive cash flow, in order to survive long-term. I think in order to create value the company must continue to downsize and focus on its most profitable regions around the world, and then just maybe it will create value.

Netflix (NASDAQ: NFLX)

Netflix has rallied 22% since Monday, and is now near breakeven for the year in terms of performance. Unlike the other stocks on this list, Netflix is still experiencing sales growth and does have a plan for future growth. However, it is also facing new competition from companies such as Amazon and Coinstar; and the company, and bullish investors, are banking on the growth and opportunity of global markets to return Netflix to its past glory. Unfortunately, the company may be losing significant market share in the U.S. thanks to increased competition.

Some believe that because Netflix has fallen that it is a cheap stock; however this is not a cheap stock, it trades with a forward P/E ratio of near 70. Overall I see a stock that is presenting false hope and investors who foolishly want to support this company and see it succeed. Once Amazon and Coinstar/Verizon have fully launched their streaming services I don’t see where the upside lies. Perhaps growth in emerging markets will exceed my expectations, but as of now I think the company needs to better diversify its business and offer an additional service besides DVD rentals and streaming services. Obviously the innovation is present, and the support of investors remain strong, therefore if I were Reed Hastings I would focus on expanding Netflix with new services and finding a more efficient way to improve margins. I simply find global expansion too risky, especially considering Netflix barely has positive operating cash flow.

Foolish Conclusion

If you are one of the many investors that are bullish on any of these companies, then I wish you the best of luck. Perhaps one of these companies will prove me wrong; however, I don’t see any effective plans or a strategy in place that answers any of the questions surrounding these companies. Each has decreased in value, have recently trended higher, and some investors are jumping to the defense that these stocks are cheap and are presenting upside. However, a cheap stock is not a good stock. Therefore, be careful and don’t forget that due diligence is not a luxury it’s a necessity, one that is even more crucial when investing in any of the companies above. 

BrianNichols has no positions in the stocks mentioned above. The Motley Fool owns shares of Best Buy and Netflix. Motley Fool newsletter services recommend Netflix. 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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