Value investing can be tough sledding because it is essential to look at more than just valuation ratios. More often than not, a stock will be a “value†for a reason, such as serious flaws in the fundamentals. The market is littered with stocks that appear to be screaming buys, only to trap investors by falling much more. Research In Motion (RIMM) was certainly one of these stocks.
Value Illusion
RIMM is the maker of the wildly successful Blackberry, which is so addictive it garnered the nickname “Crackberry.†It was the pioneer of the smartphone craze, and was a must-have gadget among the business crowd. It propelled the stock to dizzying heights, until a little company called Apple (AAPL) came along and ruined things with its iPhone.
Before last week, RIMM’s stock was trading at about 5x its own forward estimate of $7.50 per share. That is almost a ridiculously low P/E, and a dream for value investors who hope to scoop up unloved gems. There was only one problem. This estimate was a complete mirage.
The company slashed this estimate following its earnings report to between $5.25 and $6.00 per share. The stock got crushed to the tune of 21% on Friday following the news. Suddenly, that P/E doesn’t seem as low. It is still in “value†territory, but only if those estimates can be trusted and the fundamentals are solid. Neither is the case with RIMM, which makes it a classic value trap stock. Unsuspecting investors awoke to a nasty surprise last Friday.
What Can Be Learned?
As always, there are important lessons to be learned. The most important one is never to buy a stock with eroding fundamentals, even if the P/E is seriously tempting you. This is because the earnings estimates will likely go a lot lower when the fundamentals are bad, and the previous P/E is meaningless. RIMM was never really trading at that low P/E because the numbers could not be trusted. It was common knowledge and Apple and Google (GOOG) were eating its lunch and it wasn’t innovating fast enough. Make sure that the next time you want to bottom fish, you can trust the “E†in “P/E.â€
RIMM: The Classic Value Trap is an article from: 
