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With Shares Fairly Priced, Don’t Go Long (or Short) Nokia Stock

Thomas Niel

After a big drop in late October, Nokia (NYSE:NOK) is holding steady. The stock trades around $3.50/share. The telecom equipment maker has struggled to rebound after slashing guidance for the coming year. In addition, Nokia’s pause of its dividend to save cash is another factor keeping shares close to their 52-week low.

Nokia stock

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But Nokia’s recent moves could be darkness before the dawn. Nokia has paused its dividend to help fund its 5G growth efforts. On the other hand, Nokia is no Ericsson (NASDAQ:ERIC) when it comes to 5G. Nokia can talk all they want about “strategy.” Yet, when it comes to execution, they have not left investors with much confidence.

On the other hand, Nokia is cheap relative to Ericsson on an Enterprise Value/EBITDA basis. A modicum of success during the 5G gold rush could push shares higher. This makes Nokia not a great stock to go short.

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Let’s dive in, and see why staying on the sidelines is the best play with Nokia stock.

In the 5G Horse Race, Nokia Is an “Also Ran”

5G is the new frontier for the telecom equipment space. As 5G gains critical mass globally, equipment makers can profit as infrastructure build-out increases demand. A rising tide lifts all boats. But in this situation, Nokia could be the exception.

Think of it like a horse race. Ericsson and Huawei are the clear favorites. Both have distinct strengths. Nokia is a contender, but they may lack enough speed or class to overcome the competitive pressures.

Nokia is no slouch when it comes to securing commercial contracts. As of late November, the company had 50 such deals worldwide. But that pales in comparison to Huawei’s 65 deals and Ericsson’s 78. Huawei may have its troubles expanding into the United States. But the Chinese-based company has secured half of the 5G network deals in Europe (Nokia’s home turf).

Nokia is not going to get left out in the cold. But in the scramble for 5G, the company is going to have difficulties rising above its “also-ran” status.

So, how does this factor into Nokia’s future share price? Nokia could still generate profits from its limited 5G market share. But margin compression could impact financial performance in the near-term. Yet, if Nokia stock is undervalued, these risks could already be priced in. Let’s pivot to valuation, and see whether shares are a bargain, or fairly valued.

Undervalued, or Priced for Uncertainty?

Nokia looks cheap on an Enterprise Value/EBITDA (EV/EBITDA) ratio basis. Nokia shares trade at an EV/EBITDA ratio of 7.3. Meanwhile, Ericsson trades at a much higher multiple. Ericsson trades at an EV/EBITDA ratio of 10.6.

But looking at forward price-to-earnings (forward P/E) ratios, this discount is more slight. Nokia shares trade for 13.3 times FY2020 earnings. Comparatively, Ericsson trades for 16.8 times FY20 earnings.

Comparing EBITDA against forward P/E, it is clear why Nokia looks cheap but isn’t. The company’s EBITDA multiple is low because, after depreciation/amortization charges, the company is not very profitable. Looking at EBIT margins, Nokia trails Ericsson significantly. The company’s EBIT margins are just 4.4%. Meanwhile, Ericsson posts EBIT margins are more than double (8.9%).

Add in margin pressures from 5G competition. It’s clear why investors are not willing to bid up Nokia to a higher price level. As InvestorPlace’s Vince Martin recently discussed, Nokia stock is “cheaper,” but not necessarily “cheap.” I concur. Nokia is fairly priced, offering a “risk premium” to compensate for the uncertainty.

Nokia Remains a “Show-Me” Stock

It’s not all doom and gloom with Nokia stock. Yes, the company faces headwinds in the 5G gold rush. Huawei and Ericsson have more of an edge. On the other hand, Nokia is building a decent book of business. In the short-term, Nokia’s results may not be appealing. But one or two years out, the company’s operating results could see material improvement.

As it stands now, Nokia remains a “show-me” stock. Until the company can show tangible results from its 5G efforts, expect shares to tread water at the current price level. Consequently, don’t go short this stock. Nokia may have its issues. But the company’s is well capitalized. Nokia has moderate levels of debt, but cash on hand of nearly an equal amount.

Resuming the dividend could also move the needle for Nokia shares. Yield-hungry investors who bailed in October could rush back in.

But all bets are off whether Nokia will rebound, or flounder in the near-term. Shares price in this uncertainty. Yet, the stock is not undervalued, but fairly priced. So what’s the call? Stay on the sidelines. Nokia could be tempting at a lower price level. For now, not so much.

As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.

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