It’s not too often that a high-quality company such as Research in Motion (RIMM, RIM.TO) becomes so undervalued that it makes a compelling buy. But that’s exactly what has happened to RIMM over the past year.

Buy when excellent stocks are undervalued, sell when they're overvalued

One year ago the stock was trading just above $84 a share before it fell off a cliff. A very steep cliff. Since then it’s bounced around but with a definite downward trend.

The question is why?

The main reason, in my opinion, is because the market fears that Apple and Google are going to eat RIMM’s lunch. To be sure, the iPhone and Google’s Android Operating System are gaining market share in the consumer market at an explosive rate, and that appears to be the main driver in RIMM’s fall from grace.

But does it make sense? As Albert Einstein said, “a man should look for what is, and not what he thinks should be.” The market, however, appears to be looking at what it thinks should be even while RIMM continues to disprove the market’s conclusions.

Any good news is ignored while bad news, even relatively insignificant bad news, is magnified and causes the stock price to plunge.

So let’s take a page from Einstein’s book and look for what is in fact happening with RIMM.

First, its latest quarter was very strong. It posted revenues of $4.62 Billion (which is a 9% increase quarter over quarter and a 31% increase year over year), EPS came in at $1.46 per share vs. consensus estimates of $1.36 per share and even with share repurchases adding 2 cents per share, that’s an excellent result.

RIMM also shipped 12.1 million units which was an 8% increase quarter over quarter and a 45% increase year over year.

The bad news? Net subscription additions came in at 4.5 million which fell short of RIMM’s guidance of between 4.9 and 5.2 million. However RIMM has indicated that it expects Net subscription additions to be in the 5 million to 5.4 million range next quarter (a strong bit of guidance).

The other bad news? Nothing of consequence. So here’s the situation: RIMM substantially beats consensus estimates, provides very strong guidance for its next quarter and doesn’t have any really bad news to speak of, and its shares don’t do anything (they actually fell shortly after the Earnings call).

Its trailing P/E (3m) is in the single digits at a bit over 9 times earnings and its forward P/E (fye Feb. 27, 2012) is estimated to be 7.88.

P/B in its most recent quarter is 3.43 and it has a ROE of 40.90% and a ROA of 26.99% (both ttm).

No matter how you look at it, this company is cheap. But as we all know, sometimes companies are cheap for a reason. But no matter how hard I look, I don’t see the reason (other than the market’s fear of competition).

However there are two things that I believe the market is not factoring in. First, the smartphone market is in its infancy. There is still lots of room to grow. So even if Apple’s iOS and Google’s Android grow faster than RIMM, I’m not so sure that RIMM’s stellar earnings growth can’t continue, at least for the next 2 years.

Second, the market’s focus seems to be on the U.S. Yes, the margins are higher in the U.S., but there is a very big global market that RIMM is going after.

The market sees that 52% of revenue growth is from outside of the U.S. and it panics. However, revenue is revenue and as long as RIMM can keep its revenue growing like it has been, I don’t think it matters where the revenue comes from.

In fact, if the U.S. dollar continues to decline (which given the amount of debt the U.S. government is taking on is a reasonable assumption), I think it is prudent to get a large chunk of your revenue from outside the U.S.

What I believe is happening here is something called Confirmation Bias which I’ve discussed in my book, “The Pragmatic Investor.” It’s the tendency to hear only what you want to hear and ignore things you don’t want to hear in order to confirm what you think should be.

And it goes back to Einstein’s quote about looking at things the way they are. The market thinks RIMM is dead and although RIMM continues to have stellar statistics, the market searches and searches until it finds something that looks bad in order to justify its hypothesis.

However if we look at things the way they are, we can see that RIMM has no debt, it has high cash flow, it has $1.5 Billion in cash, it’s smart enough to be buying back its shares while the price is low and, most importantly, when you evaluate it using the Value Stock Selector software, it comes in at a pretty respectable 75 rating with an excellent economic moat strength of 5.

For comparison purposes, Apple rates 78 and also has a moat strength of 5 while Google rates 78 with a moat strength of 6. However Apple shares are extremely overvalued right now, selling at 1.78 times their intrinsic value. Google is more reasonable and is trading at right around its intrinsic value.

RIMM on the other hand, trades at about 12% LESS than its intrinsic value. I have to disagree with the so-called, “experts,” when I hear them say that RIMM is another Palm or Nokia. Neither Palm or Nokia had anywhere near the fundamentals strength or economic moat of RIMM. And neither had the stellar earnings growth, ROE or ROA that RIMM enjoys.

Since I first mentioned RIMM on Monday September 20, 2010, it has jumped 8.2%, but even so, I still think it is so undervalued, that it has quite a ways to go yet.

In fact I have a substantial amount of my own money in RIMM and would buy even more shares if I hadn’t hit my diversification limit.

One of the new developments is that RIMM is rumored to be announcing its tablet device next week.

The so-called, “BlackPad” is most likely no iPad killer, but if RIMM targets their existing business users, the BlackPad has a good chance of capturing that niche and adding some solid earnings to RIMM’s bottom line. Update (September 27, 2010): RIMM’s tablet device was announced today and is called the Playbook tablet. It runs a new OS based on QNX Neutrino, supports Flash and HTML 5, has a 1GHz dual-core processor, 7-inch display and can connect via Bluetooth to a Blackberry device for 3G Internet access.

Plus RIMM’s lack-luster Torch smartphone actually put up some pretty decent numbers even though it was released too late to make a huge impact in the quarter’s earnings. Given the holiday season fast approaching, I think RIMM will do well with its latest offerings.

Further, I’ve heard rumors about RIMM’s Storm 3 running the new OS 6 with a bigger touch screen, more memory and a more powerful processor than the Torch has.

It also looks as if India, and others, will reach deals with RIMM and, if that happens, another bit of uncertainty will be removed.

Finally, there is always the possibility of a short-squeeze playing itself out if RIMM’s price jumps enough to start the chain-reaction. And there’s also the possibility of someone buying RIMM if its price languishes where it is right now. With a market cap of less than $26 Billion, RIMM might look attractive to more than one 800 pound gorilla. This last possibility, I believe, puts a floor on how far RIMM has left to fall.

At the end of the day, I could be completely wrong and RIMM could end up falling sub-40 and staying there. There is no guarantee in the stock market. However I am a big fan of Warren Buffett’s idea of letting the numbers and logic, not market sentiment, decide whether to buy a stock or not. And in RIMM’s case, the numbers show that it is a very attractive buy at this price.

Keep in mind that you MUST do your own due diligence before you invest and don’t rely solely on anything I’ve said. My opinions are just that: opinions. And I throw this idea out for your education. I am not a financial advisor or a stock analyst or any other type of financial professional. So do your own research and decide whether to buy or not based on your own opinions and research, not mine.


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