Shares of Sierra Wireless (SWIR +0.00%) were down over 20% as the company missed both revenue and earnings expectations for the third quarter. Revenue fell 14.5% year over year to $174 million; Wall Street expected $191 million. Non-GAAP earnings in the third quarter last year were over $10 million, but this year plummeted to just $1 million.
While those results aren't good, so-called value investors may have noticed that Sierra Wireless actually trades below its book value, with a price-to-book ratio of 0.8. Benjamin Graham and Warren Buffett are both respected investors who have advocated buying stocks that trade below 1.2 book value -- making Sierra Wireless look like a steal at these levels. But there's more to investing than valuation metrics, and Sierra Wireless may actually be a value trap.
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A Buffett stock?
Berkshire Hathaway CEO Buffett is known for his annual letter to shareholders. For years he has highlighted his company's book value in that letter's opening, and has been known to repurchase shares of the company when its valuation falls below a 1.2 price-to-book value.
However, in this year's shareholder letter, Buffett stated that Berkshire Hathaway's book value "has lost the relevance it once had." The reason is multifaceted, but at the risk of oversimplifying, Buffett draws a distinction between the intrinsic value a business has and its book value.
Boiling an investment down to a single valuation metric is a risky strategy, as one metric doesn't tell a whole story. Sierra Wireless traded below book value in early 2016; had you invested in that "bargain" then (like me), you'd be down over 10%. The market over that period is up nearly 60%. The reason for this disparity is simple. Over the past four years, Sierra Wireless' revenue is only up about 15%, and its net income is actually down. Full-year non-GAAP earnings were $25 million in 2015. But this year the company is only guiding for $23 million.
I don't think a value investor like Buffett would be interested in Sierra Wireless, even at 0.8 price-to-book value. Stagnant businesses typically don't make great investments, no matter how cheap the stock looks.
But what about the Internet of Things?
In 2015, Sierra Wireless began branding itself as a company "building the internet of things." For years now, the Internet of Things has been an investing buzzword with an overhyped growth trend. By way of example, a 2016 graphic by Statista estimated that there would be nearly 27 billion connected devices this year. In reality, there are fewer than 20 billion right now, according to IoT Analytics. That's a big miss in just three years' time.
While perhaps the Internet of Things hasn't developed quite as fast as everyone thought, it's hard to deny its current growth and long-term prospects. Yet despite these trends being in Sierra Wireless' favor, it just can't seem to capture this opportunity. The company's IoT revenue was down 2% year over year in the third quarter.
What to do
If you're already a Sierra Wireless investor and believe it's just a matter of time before its IoT bet begins to come to fruition, there are a couple of things you can take comfort in while holding. It's true that it trades below book value, and a significant portion of that ($87 million) is in cash. Further, the company isn't burning through cash. Rather it's free-cash-flow positive, generating $2.7 million in Q3 despite an otherwise poor quarter. At least it can be said that the company is on solid financial footing.
While I don't believe the stock's fall is a buying opportunity, two things could change the narrative. First, the next big growth driver for the IoT will be 5G networks. Sierra Wireless doesn't expect much until 2021, but management mentioned that shipments could start late next year. High demand early would be a welcome signal that Sierra Wireless' fortunes may be changing. And second, the company has some bad habits, like lowering guidance in the fourth quarter last year and missing earnings guidance in the second quarter this year. This company simply must do a better job at predicting its own business and operations. Establishing a track record in the coming quarters of maintaining guidance and hitting it would go a long way toward that end.
