Reading InvestorPlace contributor Josh Enomoto’s Feb. 1 article about Nokia Corp (ADR) (NYSE:NOK) reminded me about my own post about the Finnish telecom company that appeared only a few days earlier in which I suggested Nokia stock was “a dog with fleas” and not worth owning at $5 or $50.
Ouch.
I must have been in a terrible mood when I wrote that because it’s probably a tad harsh. There are plenty of worse companies to own in this world than NOK. In fact, having looked at three particular numbers more closely, I think it’s appropriate for me to change my viewpoint.
I still wouldn’t buy Nokia stock, but I do see how aggressive investors might be attracted to it. Here’s why:
1. Earnings Yield
Joel Greenblatt, creator of the Magic Formula and a former hedge fund manager, likes to buy stocks that are both cheap and good. To determine what’s cheap, he uses earnings yield defined as earnings before interest and taxes (EBIT) divided by enterprise value rather than market cap to account for the entire business and not just the equity.
In Nokia’s FY16, which ended Dec. 31, 2016, the company’s EBIT was $2.3 billion on a non-IFRS basis. Its enterprise value was $25.9 billion, resulting in an earnings yield of 8.9% or a P/E ratio of 11.3. By comparison, the S&P 500 is 20.6, or almost double its valuation.
Nokia stock is definitely cheap.
2. Return on Capital
The second part of Greenblatt’s formula is concerned with achieving above-average returns on a company’s assets. In this case, he takes EBIT and divides that by capital employed (net working capital, which is current assets minus current liabilities, plus property, plant, and equipment net of depreciation, less excess cash).
Greenblatt wants to own companies that are generating a return on capital in excess of 50%. In the case of Nokia, its return on capital in 2016 was 95.8% based on the EBIT mentioned above ($2.3 billion) and capital employed of $2.4 billion.
There are many different ways investors define return on capital and this is by no means the only way to examine the productivity of its assets. However, the next number does a good job making this particular point somewhat extraneous.
3. Cash
Nokia has $10.2 billion in cash which works out to $1.79 per share. That means a potential buyer (assuming no premium) would get the entire business for $6 billion less than the current market value of all Nokia stock.
So, if an acquirer were to bid $5.14 per share (February 28 closing price) for all of the Nokia stock, that company would already have a 20% downpayment (Cash-LTD=$1.05/share) to buy Nokia’s entire business without lifting a finger.
Granted, I’m talking about non-IFRS numbers, not the reported numbers which showed an EBIT loss in 2016 of $1.1 billion. Any time you play with non-GAAP, non-IFRS numbers, you’re potentially playing with fire because they can swing both ways, good and bad.
Bottom Line on Nokia Stock
In many of Warren Buffett’s annual shareholder letters, including this year’s version, he’s highly critical of nonstandard accounting metrics. The truth is, his own company uses non-GAAP numbers from time to time, so it’s hard to know where to draw the line.
Personally, I tend to avoid companies with a lot of non-GAAP mumbo jumbo because I’m not smart enough to know whether someone’s pulling the wool over my eyes or simply trying to make an apples to apples comparison.
That doesn’t mean you should shy away from companies like Nokia and Nokia stock. If you’re smart enough to read between the lines and really understand technology — go for it.
I can’t, so as they say on the Shark Tank, I’m out.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
