Falling Knife In Motion (RIMM)

It's always dangerous to try to catch a falling knife. Buying a former highflying stock at a discount price is certainly tempting; but make sure you grab the handle, not the blade.

Research in Motion (Nasdaq:RIMM) is one such falling knife. On Friday, after Research in Motion slashed its profit margins guidance for coming quarters, the stock plunged 27%. The stock is down 55% from its highs in June. Is its safe to reach out for Research-In-Motion? To find out, it's worth taking a look at the company's valuation.

Beware of Sharp Objects
Research In Motion's enterprise value is about $37 billion and by my calculations the company will probably generate about $1.4 billion of free cash flow this year. Research In Motion is therefore trading at about 26 times free cash flow. That multiple is still on the high side, but it is much more reasonable than the multiples that market has given it over the past two years. I reckon a safe multiple for Research In Motion is about 20-25.

The stock is finally close to that range and could be approaching a floor. If the company's business really falls apart, the stock price could drop below $50 per share which would be far below today's $67 share price. That's unlikely, but not impossible as expectations of market growth fall across the broader market. (To learn more, read Analyze Cash Flow The Easy Way.)

DCF Tells the Story
I've also been working on a discounted cash flow analysis. My rosiest forecast assumes that Research in Motion will grow its free cash flow of $1.4 billion by 20% over the next four years, then by 10% through year ten, and 5% for years 11 through eternity. I've also assumed a discount rate of 10%.

This scenario - which demands lot from the wireless messaging specialist - generates a share valuation of $65.40. In other words, Research in Motion has pretty aggressive growth built into its current price.

Over the next few quarters, there is the chance that as the global economy weakens and it faces heightened competition from the likes of Apple (Nasdaq:AAPL) and Palm (Nasdaq:PALM), we could start to see Research In Motion's revenue forecasts trimmed further for 2009. The stock could weigh on the downside until that's over.

Bottom Line
In this market, Research In Motion is a risky place to put your money. Sure, it's nearing fair value. But stocks that fall fast tend to fall much further than you might expect. And for buyers that can hurt.

By Ben McClure