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BlackBerry Picked for Downgrade: 3 Things You Need to Know

By Rich Smith - May 19, 2016 at 9:00AM

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The main thing: Just because a stock has lost almost all its value doesn't mean it can't go even lower.

It's been a long time since BlackBerry (BB 1.11%) stock owners had much fun on the stock market. Over the past five years, shares of the Canadian smartphone maker have lost 85% of their market capitalization. The stock is down 34% over just the past year -- and down 28% so far this year alone.

It's enough to make an investor wonder: Is there any hope for BlackBerry at all?

One analyst votes no.

Now here are three things that you need to know about it.

"What's that? You say I should have sold BlackBerry in 2011? Now you tell me!"

Thing No. 1: Macquarie hates BlackBerry!

Initiating coverage of BlackBerry stock with an underperform rating yesterday, analysts at Australia-based Macquarie Research set a $6.90 target price on the stock. It may sound surprising to learn that someone chose to wait till after BlackBerry had lost 85% of its market cap to recommend selling it.

In fact, though, according to our records here at Motley Fool CAPS, Macquarie has in fact gone on record against BlackBerry in the past -- it's apparently called the bottom before (but now Macquarie sees the bottom falling out again). What's more, the last time Macquarie inveighed against BlackBerry stock, its underperform rating went on to outperform the S&P 500's performance by 60 percentage points. So there are worse analysts you could be taking points from on BlackBerry than Macquarie.

And yet, here's another surprising fact: While Macquarie is telling investors to sell BlackBerry stock, its $6.90 price target implies that the stock will actually go up over the next 12 months (BlackBerry stock currently costs $6.67 per share) instead of down!

Thing No. 2: Up is a relative term

So why tell investors to sell an undervalued stock? Here's one reason: Macquarie's new target price on BlackBerry implies that the stock will gain less than 3.5% in share price over the next 12 months. When you consider that even in the most recent decade, and plagued by the stock market crash that accompanied the Great Recession, the S&P 500 as a whole gained 4.9% over the past 10 years, that 3.5% projected profit at BlackBerry does look a little light.

And when you consider that over longer stretches of time, the S&P has averaged gains closer to 10% per annum, BlackBerry stock looks even less attractive (to Macquarie, and to us as well).

Thing No. 3: But isn't BlackBerry too cheap to go lower?

All that being said, the possibility of a 3.5% profit might not seem so bad with banks paying less than a penny a dollar in interest rates these days -- so long as an investor could be certain that BlackBerry stock won't go down any more. And with the stock selling for an 85% discount to what it cost five years ago, BlackBerry can't go down much more, can it?

Well, actually, yes, it can. It could go down quite a bit.

The most important thing: Valuation

Here's why: Five years ago, BlackBerry was at the top of its game, raking in $19.9 billion in annual revenue, earning $3.4 billion in profits, and generating roughly $3 billion in annual free cash flow. But my, how times have changed. Last year, BlackBerry brought in just $2.2 billion in revenue, and BlackBerry stock hasn't earned an annual profit in more than four years.

Granted, BlackBerry is currently generating cash. Subtract capital spending and software costs from operating cash flow, and S&P Global Market Intelligence data show that last year, BlackBerry generated positive free cash flow of $155 million. That's about one-twentieth the amount of free cash flow the company was generating just five years ago.

Weighed against the company's $3.5 billion market capitalization, that works out to a price-to-free-cash-flow ratio of 22.6 on BlackBerry stock. And that seems a pretty rich price to pay, given that the stock pays no dividend at all, and is expected to produce long-term profits growth of just 5% annually over the next five years.

Macquarie is right when it tells you to sell BlackBerry stock. It probably won't go up much at all -- and it definitely can go lower.

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