RIMM vs. AAPL; Another Economic Recovery Play

What’s the better economic-recovery play?

These companies were both major media darlings before the recession, posting strong revenue and earnings growth, and sporting sky-high PE multiples.  Yet with the recession, many stocks got CLOBBERED, and these companies are now both trading at a PE of around 22.  So the market is pricing these companies similarly; is the market right to do so, or is there hidden value in one of these companies?

Looking at their PE ratios of 22ish, there are two ways the companies can go up in value.  They can make more money, driving up the E side of the equation, or sentiment towards the company can improve, driving up the ratio itself.  Since sentiment is also based on earnings, earnings are definitely the most important variable here. 

So it wins revenue growth wise, where do they stand on earnings growth?  It’s all about the bottom line right?  Well AAPL managed to grow its earnings 14.84% over that time span.  Once again, this is a lot better then the vast majority of companies, whose earnings have in fact fallen throughout this recession.  How does RIMM compare?  Well as you may have guessed based on the revenue numbers, RIMM beat apple squarely in terms of growth here as well.  RIMMs earning growth clocked in at 25.88%, falling significantly short of their revenue growth, but still trumping apple by a fair margin.  Assuming the recession doesn’t get significantly worse, the fact that these companies are both growing earnings at such a fast pace indicates they are likely to continue that trend well into the future.  Neither of these are exactly discount-brands either, so coming out of the recession, they’ll have the added benefit of selling to an expanded market of consumers, which should give them a short term boost in earnings and revenue growth.  That said, have to give it to RIMM on this metric as well; its growing earnings faster then apple is.

So they’re making money hands over fists.  Wheres the risk?  Looking at their debt situations, they’re in fairly good shape.  AAPL and RIMM have current ratios of 2.46 and 2.29 respectively; This means that they have over $2.00 of cash and assets that will soon be converted to cash (eg: inventory) for every $1.00 of short term debt.  In other words, no real short term debt risk.

Are they sitting on piles of long term debt?  Not at all!  In fact, both companies share the remarkable property of not having any long term debt.  On top of that, they both have very significant cash positions.  AAPL is sitting on 25 billion in cash and short term investments (total assets = 43 billion), while RIMM is sitting on 1.5 billion in cash and short term investments (total assets = 8.1 billion).  That being said, keep in mind that to keep their current ratios healthy in the 2-3 range, they’d have to keep most of that cash on hand and not spend a significant portion of it, so they aren’t quite at a stage where they’re likely to be using that cash to enhance shareholder return.  The large cash position is more a margin of safety type deal.

A good short and long term debt position then.  What else could threaten the stock price?  If this recession gets a lot worse, they could go from fast growing companies to slightly contracting companies.  While this may only lower the Earnings portion of the PE ratio by 5-10%, the big loss would be caused by a drastic fall in the PE ratio.  A company that is contracting may only get a PE ratio of 10-15, and if people don’t believe the company will be able to grow earnings in the future, a PE ratio of even lower then that is possible.

Looking at AAPL, I can see a quarter with decreased earnings as a possibility, although the fact remains that after the recession ends, there is likely to be a large boost in revenues.  This common knowledge is likely to keep AAPL at a fairly lofty PE ratio.  If an earnings report comes in where AAPL DID lose ground compared to the quarter 1 year prior, then that’s when I’d begin getting worried, as its likely to cause the PE ratio to fall significantly, and that would have a massive effect on the stock price.

Now examining RIMM, I don’t envision them running into that problem.  With such strong revenue growth, it is bound to continue into the next quarter as well.  Even if they don’t come out with earth-shattering numbers like their previous 84% growth in revenues, it’s almost a given that revenues will be up, and earnings will be up.  With that in mind, the biggest risk; a drop in PE ratio as the market factors in the possibility of very low future earnings growth, is practically eliminated.  RIMM definitely scores the upper hand here.

That being said, If this recession ends up going longer then people expect; instead of a recovery in 2010, it lasts as long as 2011, 2012, or further, all bets are off.  In that kind of situation, the prolonged and continuous job losses would eventually impact the markets for both of these companies products to the point where earnings would definitely come in lower, the PE ratios would definitely drop drastically, and an investment in either of these companies would definitely lose money.  Yet if you agree that we may see a recovery by the end of next year, then AAPL and RIMM have some definite potential.

So where do I see AAPL and RIMM going?  Well at this point, I’d say that RIMM has without a doubt the better prospects between the two.  Assuming a non-Financial Armageddon scenario, then this is how I see the situation.  Within a year of the recession ending, the market is likely to push stocks that are growing quickly back up to a PE ratio of at least 30-35, for a gain of 36-59% (from the current PE ratio of 22).  If a strong company like RIMM also manages to increase earnings another 20% by the end of that year, then that would increase the overall stock price by 63-90%, which would put RIMM at 118 per share conservatively, up to as high as 136.  Of course, earnings growth of higher then 20% will put the stock price up possibly higher then that, and if the market is more optimistic, that also could lead to a higher PE ratio then the range given above.

So is now the time to buy these companies?  Not quite yet.  The market has had an enormous rally over the last couple months, and is due for a pullback in the nearby future.  The technology sector overall is currently in an overbought state, according to the BP chart, so we should wait for a reversal before trying to get into these 2 stocks.  In fact, i wouldn’t be at all surprised if the dow went back down to 7400 or less..  But when it does, these are definitely 2 stocks to keep on your watch list, for as the recession fades, these stocks are likely to be among the top performers.