When it comes to stockpicking, some of the biggest gains can be made by betting
against the crowd. By definition, it’s never the most fashionable thing to do.
And sometimes being a contrarian can be downright uncomfortable. But every now
and then the opportunities are just too big to ignore.
I believe this sort of opportunity is unfolding with Ericsson (Nasdaq: ERIC),
the Swedish maker of telecom infrastructure equipment. Ericsson shocked the
market in mid-October when it announced an unforeseen shortfall in thirdquarter
earnings. Its shares immediately went into a free fall, losing more than a
quarter of their value in one trading session. It was a painful day.
There’s no question that Ericsson had a bad quarter. But a 25% one-day
plunge–equivalent to about $12 billion of the company’s market cap–strikes me as
a wild overreaction. It takes something much more dramatic than an earnings miss
to swing the intrinsic value of a company that much overnight. Short-term, yes,
Ericsson has some problems to work out. Long-term, the fundamental story is
still very much intact. Let’s take a closer look.
First, the bad news. A big part of the reason for Ericsson’s shortfall was a
delay in network upgrades by phone companies in North America. Unless you
believe that Americans are going to suddenly stop using their cell phones for
things like sending pictures and listening to music, this is almost certainly a
short-term problem.
Don’t forget about the turmoil that seized the credit markets during the
third-quarter of 2007. Is it really surprising that some telecom companies might
have put some spending plans on hold in such an environment? These equipment
purchases might have been delayed, but they need to be made at some point, and
Ericsson is the industry’s leading supplier. As bad as things may look for
Ericsson, it is still miles ahead of its ailing competitor Alcatel-Lucent, which
had several major profit warnings in 2007 and has struggled to reap the benefits
of its transatlantic merger.
Another knock on Ericsson is that their margins will be under pressure because
they sell a lot of gear in places like China and India, and the pricing on those
contracts is lower than in developed markets.
But Ericsson is building a dominant position in these rapidly growing countries.
It would be foolish for them to pass up on heavy investments in China and India
simply because it might be a drag on margins for a few quarters. Ericsson is
doing the right thing to prepare for the future. Wall Street–big surprise–is
being short-sighted.
But the numbers tell the most compelling story of all. Ericsson is now trading
at about 13 times earnings and pays a 2% dividend yield. It is debt free and
consistently generates a healthy 20%-plus returnon- equity. Its financial
strength will help it ride out the short-term bumps.
In some ways, Ericsson reminds me of another Scandinavian telecom company that
has been one of the biggest winners in the Forbes International Investment
Report model portfolios: Finland’s Nokia (nyse: NOK). Nokia’s stock has
gained 83% since I named it as one of my top picks in January 2007.
Nokia has faced plenty of skepticism over the years. Analysts argued that cell
phones were becoming a saturated market. The skeptics also said Nokia would face
competition from cheap upstarts in countries like China. The argument was that
most folks who can afford phones already have them, and those who don’t will
probably end up buying cheaper ones than Nokia’s models. So far Nokia has proven
the skeptics wrong and remains the leading global brand in mobile phone handsets
despite plenty of stiff competition.
To be sure Ericsson and Nokia are no longer the red-hot growth names that they
once were back in the 1990s TMT bubble. But when it comes to global demand for
cell phones packed with rich features and the sophisticated infrastructure
that’s required to support them, we’re still in the early innings. Mobile phone
data traffic is exploding and today’s networks will need to be upgraded to
accommodate all of it. Given its bargain valuation I believe now is an excellent
time to accumulate shares of Ericsson.
