There’s really one simple question when it comes to Nokia (NYSE:NOK): how many disappointments can investors stomach? The answer at the moment seems to be: at least one more.
After all, NOK plunged after third quarter earnings last month. And it wasn’t just the matter of results in Q3 missing expectations (though they did). Nokia cut its full-year outlook, and yet another strategic change appears on the way for a company that can’t seem to get its approach fixed.
Yet, the stock is rallying once again, and has recaptured nearly all of those post-earnings losses.
Truthfully, it’s hard to see why. The problems highlighted in Q3 aren’t new. Rather, they’re of a kind with the long-term inability of Nokia to drive consistent growth or shareholder returns.
Each time Nokia has disappointed in the past, there have been investors willing to give the company another chance. More investors have done the same over the past four weeks. But particularly at this point, there’s not much reason to join the bullish group. Nokia simply has burned all of the investor credibility it has, and it will take a long time for the company to regain that credibility — if it can do so at all.
History Rhymes
The Q3 2020 earnings release certainly mimics the Q3 2019 report. Last year, Nokia cut its guidance. At the time, Nokia expected adjusted earnings per share of 0.25 EUR to 0.29 EUR in 2019, which was supposed to spike to 0.37 EUR to 0.42 EUR in 2020.
This year, Nokia again cut its guidance. 2020 adjusted EPS now is expected to come in at 0.20 EUR to 0.26 EUR. That’s a modest reduction from the 2020 outlook updated a year ago, an outlook reiterated through Q2.
Obviously, this year’s cut isn’t quite as drastic as last year’s. But lowering already-reduced expectations is hardly good news.
More broadly, this is not a new problem. Nokia hasn’t met expectations for years now and its stock has suffered as a result. Even including dividends, Nokia shareholders have lost about 44% over the past decade. 3- and 5-year returns too are sharply negative.
Over those timeframes, broad markets have soared. NOK, meanwhile, has been left behind.
Nokia Stock Rallies
Interestingly, NOK has rallied over the past year, gaining about 17%.
Timing is part of those gains, as the stock was at depressed levels 12 months ago. And that one-year rally has been driven almost totally by the recovery since this year’s Q3 release.
Still, investors are giving NOK another chance. From a distance, I can see why.
The 5G (fifth-generation) wireless tailwind should remain intact. Valuation is reasonable as well. At the midpoint of even the lowered 2020 guidance, NOK trades at less than 15x earnings.
But if you look closer, those aspects of the bull case start to fall apart. In 5G, Nokia is losing to Ericsson (NASDAQ:ERIC) even as China’s Huawei has been hit by national security concerns.
As for valuation, the stock has been cheap for some time looking to guidance or out-year estimates. But with expectations consistently being too high, the stock winds up falling anyway.
The same pattern may well repeat this time around. After all, the problem in Q3 wasn’t just that Nokia projected weaker-than-expected earnings this year. The company also guided for profit margins to fall further in 2021. That pressure is coming in large part due to what looks like a multi-year headwind.
Time to Move On
The issue with Nokia’s earnings isn’t just that the outlooks for this year and next were cut. It’s that the company, by its own admission, has to revamp its entire go-to-market strategy.
Most notably, Nokia says it needs to ramp up its spending on research and development. That’s an obvious problem for two reasons.
First, there isn’t a ton of room on the profit front to boost that spending. Adjusted operating margins are guided to about 9% this year, and 7-10% next year. But R&D spending in the first nine months of this year was more than 18% of sales. Ramp that spending 10%, all else equal, and profit declines in the range of 20%.
Second, the cited need for increased R&D is itself an admission that Nokia products simply aren’t good enough right now. This isn’t Amazon (NASDAQ:AMZN) or Tesla (NASDAQ:TSLA) sacrificing near-term profit to cement market dominance. This is a company playing catch-up at a time when it’s supposed to be taking advantage of the 5G trend.
Now, yes, the stock is cheap. But, again, it’s been cheap for most of the past decade. And in context, right now, it’s hardly that cheap. 15x this year’s earnings is not a great multiple given that profits seem likely to decline next year. Meanwhile, ERIC trades at 17x forward earnings, while fellow networking players like Cisco Systems (NASDAQ:CSCO) and Juniper Networks (NYSE:JNPR) have similar valuations to NOK, if admittedly problems of their own.
So why have investors bid NOK back up? The simplest answer seems likely to be the combination of a ‘cheap’ share price and the potential 5G tailwind. But given the long-term history and Q3 results, that hardly seems like enough.
On the date of publication, Vince Martin did not have (either directly or indirectly) any positions in the securities mentioned in this article.
