Research in Motion Ltd (RIMM) is a leading designer, manufacturer, and marketer of innovative wireless solutions for the worldwide mobile communications market. RIMM is known principally as the maker and provider of BlackBerry wireless devices and e-mail services.
RIMM Value Investing Approach
This model is prepared in a very simple and easy way to value a company, it adopts the investment style of the Father of Value Investing Benjamin Graham. The essence is that any investment should be purchased at a discount, meaning the true value should be more than the market value. Graham believed in fundamental analysis and was looking for companies with a sound balance sheet and with little debt. The basis for this valuation is the company’s five years of historical financial records, the balance sheet, income statement, and cash flow statement. We calculated first the enterprise value as our first step. We believed this is important because it measures the total value of the company.
The Investment in Enterprise Value
The concept of enterprise value is to calculate what it would cost to purchase an entire business. Enterprise Value EV) is the present value of the entire company. Market capitalization is the total value of the company’s equity shares. In essence, it is a company’s theoretical takeover price, because the buyer would have to buy all of the stock and pay off existing debt, and taking any remaining cash.
Enterprise Value = Market Capitalization + Total Debt – (Cash and Cash Equivalent + Short Term Investment)
The market value of Research in Motion Ltd was decreasing at 29 percent averages well as its enterprise value at 34 percent average. The enterprise value total debt was 0.005 percent. Thus resulting in a no-debt-equity ratio of zero, impressive. While cash and cash equivalent was 7 percent of the enterprise value, enterprise value was lesser by 7 percent than the market value. Buying the entire business of RIMM would mean buying 100 percent of its equity, with no debt.
The market price of RIMM has dropped at a rate of 27 percent average. The buying price to date, October 27, 2012, for the entire business was $1735 at $3.31 per share.
Net Current Asset Value (NCAV) Approach
Net Current Asset Value (NCAV) Method
The net current asset value approach for RIMM shows that the stock was trading at an overvalued price because the market price was greater than the 66 percent of NCAV. The result of 66 percent was only 7 percent of the market price.
Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation
Another stock test by Graham is by using market capitalization and dividing it to net current asset value (NCAV). The idea is, if the result does not exceed the ratio of 1.2, then the stock passes the test for buying.
The table above indicates that in MC/NCAV method, the price was overvalued from 2007 to 2011 because the ratio was greater than 1.2 thus telling us the stock did not pass the stock test. While during ttm6 2012, the price was undervalued because the result of the ratio did not exceed 1.2 therefore, the price was cheap.
The margin of Safety (MOS)
The margin of safety is used to identify the difference between company value and price. Value investing is based on the assumption that two values are attached to all companies – the market price and the company’s business value or true value. Graham called it the intrinsic value. The difference between the two values is called the margin of safety. According to Graham, the investor should invest only if the market price is trading at a discount to its intrinsic value. Value investing is buying with a sufficient margin of safety. Graham considers buying when the market price is considerably lower than the intrinsic or real value, a minimum of 40 to 50 percent below. The enterprise value is used because, in my opinion, it is a much more accurate measure of the company’s true market value than market capitalization.
Intrinsic Value = Current Earnings x (9 + 2 x Sustainable Growth Rate)
EPS, the company’s last 12-month earnings per share. G: the company’s long- term (five years) sustainable growth estimate. 9: the constant represents the appropriate P-E ratio for a no-growth company 2: the average yield of high-grade corporate bonds.
The intrinsic value factors earning per share and the sustainable growth rate. To arrive at the intrinsic value, we must calculate first the annual growth rate. Then by 9+2 multiplied by the growth or the sustainable growth rate (SGR). The factors used in the calculation were explained above.
As we can see, the intrinsic value has increased from 2007 to 2010 averaging 42 percent. It experienced a sudden drop of 87 and 94 percent in 2011 and ttm6 2012, respectively.
The sustainable growth rate factors return on equity and payout ratio. RIMM was not paying the cash dividend to its shareholders’, therefore, there was no payout ratio. Thus, the result of the sustainable growth rate is the same as the return on equity. In the calculation above, I have used the relative return on equity.
The graph above shows that the intrinsic value line was higher than the price or enterprise value. This goes to show that there was a margin of safety for RIMM from 2007 to ttm6 2012. In the trailing twelve months, it had almost intersected with each other. If we put in figures or in percentage the distance between the two lines, that is the margin of safety. In the above table, the average percentage from 2007 to ttm6 2012, was 69 percent, this is the distance of the space between the two lines from 2007 to ttm6 2012. In 2010, the intrinsic value soared up very high at a rate of 63 percent from 2009, then a sudden fall in 2011 at a rate of 87 percent and it continues to fall in ttm6 at 94 percent.
There are two approaches in calculating SGR, and that is the relative and the average approach.
Using the average approach, it produces a higher result. On the other hand, this does not work for the margin of safety in which it was using the relative approach gave us a higher percent of MOS.
Price to Earnings/Earning Per Share (P/E*EPS)
This valuation determine whether the stocks are undervalued or overvalued by multiplying the Price to Earnings (P/E) ratio with the company’s relative Earning per Share (EPS) and comparing it to the enterprise value per share, we can determine the status of the stock price.
The price was undervalued because the enterprise value was lesser than the P/E*EPS ratio. The stock was trading at an undervalued price because the enterprise value was 80 percent average of the P/E*EPS ratio.
There is another approach in calculating the P/E*EPS valuation and that is the average approach.
Using the average price to earnings ratio produces a higher percentage because it takes into consideration the performance of the company in the prior periods.
Enterprise Value (EV)/Earning Per Share (EPS) or (EV/EPS)
The use of this ratio is, to separate price and earnings in the enterprise value. By dividing the enterprise value into the projected earnings (EPS), the result represents the price (P/E) and the difference represents the earnings (EPS).
In the EV/EPS valuation tells us that the price (P/E) was 30 percent average. On the other hand, the earnings (EPS) was 70 percent on average.
Enterprise Value (EV)/ Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA).
This metric is used in estimating business valuation. It compares the value of the company inclusive of debt and other liabilities to the actual cash earnings exclusive of non-cash expenses. This metric is useful for analyzing and comparing profitability between companies and industries. It gives us an idea of how long it would take the earnings of the company to pay off the price of buying the entire business, including debt.
It will take 9 years or 9 times cash earnings of Research in Motion Ltd to cover the costs of buying the entire company.
The market value of RIMM was decreasing at a rate of 29 percent average. While the enterprise value was also decreasing at a rate of 34 percent average. RIMM has a debt-equity-ratio of zero, impressive. Cash and cash equivalent were 7 percent. Buying price to date, October 27, 2012, was $1735 at $3.31 per share. Buying the entire business will be buying 100 percent of its equity.
The net current asset value approach tells us that the stock of RIMM was trading at an overvalued price. Because the price was trading above the liquidation value of the company. While the MC/NCAV indicate that the price was overvalued because the ratio was greater than 1.2.
The margin of safety
On the other hand, the average margin of safety was 69 percent. In 2010 the intrinsic value was the highest at 92 percent. Using the average return on equity, the margin of safety was 66 percent.
The sustainable growth rate was $27 average, while the annual growth rate was $63 average. Moreover, the return on equity was $27 average. The margin of safety was at $206.98 average.
Furthermore, the price was undervalued because the enterprise value was lesser than the result of P/E*EPS. In an average approach, the P/E represent 146 percent while in relative approach, the P/E was 132 percent.
The EV/EPS indicate that the price (P/E) represents 30 percent and the earnings (EPS) was 70 percent.
In addition, it will take 9 times the cash earnings to cover the cost of buying the entire business.
The margin of the safety was 69 percent and the price was trading at a price undervalued. Therefore I recommend a BUY in the stock of Research in Motion Ltd (RIMM).
Researched and Written by Cris