Short This Troubled Mobile Phone Maker Before It Plummets

At one point in its history, this stock was synonymous with success in the cellphone market. But not any longer.

During the past year, it has reported billions in operating losses, closed several of its worldwide manufacturing sites, cut tens of thousands of jobs, and has lowered the price of its flagship products due to poor sales.

This company has faced bankruptcy before and could be approaching it once again. Shares of the stock have plummeted about 47% year-to-date and look poised to drop further.

All of these reasons make the stock of Finnish cellphone maker, Nokia (NYSE: NOK), potentially an excellent short.

The picture wasn’t always this grim. Between 1998 and 2011, Nokia sold the most mobile phones in the world. Even today, Nokia sells an average of one million phones a day.

But the company has bled market share as it’s fallen behind more innovative smartphone leaders, such as Apple (Nasdaq: AAPL) and Google (Nasdaq: GOOG). Between 2005 and 2010, while Apple was bringing its revolutionary new iPhone and iPad technologies to market, Nokia was focusing on developing low-end mobile phones. While it succeeded in making mobile technology accessible to developing nations, it missed out almost entirely on the smartphone revolution.

Now trying to play catch-up, the company has entered the smartphone race, perhaps too late. It’s teamed up with Microsoft (Nasdaq: MSFT) to develop two new smartphones — the Lumia 820 and 920 — which run on Microsoft’s Windows 8 platform.

To generate sales for the 2012 holiday season, Nokia’s Lumia phones will be released in November — in time to compete with Apple’s new iPhone 5. Industry analysts think Nokia will lose out to Apple. They expect Nokia will sell less than four million phones in the quarter. In contrast, Apple received more than two million iPhone 5 orders in the first 24 hours the product was released! As such, the holiday season could be the defining “make it or break it” moment for Nokia.

The technical outlook for Nokia certainly looks foreboding.

At one point during the peak of the tech bubble in 2000, Nokia traded north of $50 a share. Even in late 2008, it approached $40. A major downtrend line can be drawn over the price action of the past two years beginning late January 2011. Since that time, the shares has fallen more than 85%, from a high near $11.15, in early 2011, to an all-time low of $1.63 in July 2012.

Since hitting this low, shares have rebounded, peaking at a high of $3.39 in August, before settling back to current levels near $2.80.

At this level, shares are again pushing against resistance, dating back to the spring. The minor uptrend line off the July low currently intersects the chart at about $2.65. If this trendline is broken, it’s likely the old low near $1.63 would be retested.

As such, shorting the stock if the trendline was broken could yield gains of about 38%.

The technical outlook supports the bearish fundamentals.

For the upcoming quarter, analysts project poor phone sales will cause revenue to drop 29% to $9 billion, from $12.7 billion in the comparable year-ago period. For the full 2012 year, analysts expect revenue will fall 24% to $38.3 billion, from $50.5 billion last year.

The earnings picture is equally grim. For the upcoming quarter, analysts predict slowing demand for Nokia phones will push the company into a loss of 13 cents a share, from a gain of 4 cents in the year-ago quarter. For the full 2012 year, earnings are also expected to be negative, falling nearly a dollar, from 38 cents last year, to a loss of 41 cents this year.

From a valuation standpoint, Nokia is poor. The company has a return on equity (ROE) of -36%. Its five-year projected PEG ratio (price-to-earnings divided by growth rate) is very high at 5.4. A PEG of one or under is thought to represent good value while anything over two is considered to be very pricey.

Risks to Consider: If Nokia can use its Lumia phone to compete with the iPhone5, the company stands a fighting chance of surviving. But if Nokia phone sales are poor, as industry analysts expect, the company could sink further, potentially reaching penny stock status.

Action to take –> Place a sell-on-stop order at $2.64, a few cents below the minor uptrend line good until Friday, Oct. 19. Set a stop-loss at $3.41, slightly above the August spike high. Set a target of $1.63 for a potential 38% gain. Risk/reward ratio is 1.3:1.

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