Riddle me this, Fool: When is getting your profits cut nearly in half ... good news?

Answer: When you're GPS device-maker Garmin (NASDAQ:GRMN). In fact, when you're Garmin, a 44% drop in profit isn't just good news; it's fantastic. More to the point, it's good enough for a 5% bump in the stock price (at last count).

As you've probably heard by now, Garmin reported its Q4 and full-year earnings news yesterday:

  • Quarterly sales declined 14%.
  • Profits declined 44% year over year, causing the company to "miss estimates " by a mile (or by $0.20 per share).

Yet none of this is news to Garmin investors, who've built up thick mental calluses against such numbers. Pulling back and examining the big picture,  we see for the year that:

  • Revenue rose 10% to $3.49 billion, headlined by 8% growth in the flagship "automotive/mobile" segment and a whopping 26% jump in sales of "outdoor/fitness" navigation devices.
  • Per-share profits dropped only 11% to $3.48.
  • Free cash flow came in at $743 million, up 41% from last year, and slightly ahead of "net earnings" as reported under GAAP.
  • Most important of all (and probably helping boost that FCF number), Garmin stuck by its stated goal of reducing inventories. Year-end levels stood at $425 million, down 16% year over year.

Inventory's key
That last number, Fools, is the key to Garmin's entire investment thesis. It reassures us that management backs its words with deeds. 

Nearly as important, though, is how Garmin went about fulfilling its pledge to bring inventories in line with sales trends. Even as the company unloaded its excess inventory, gross margins shed only 150 basis points for the year, while operating margin approached 25%.

Such profits will position Garmin well as it goes head to head with Nokia (NYSE:NOK), Apple (NASDAQ:AAPL), and Motorola (NYSE:MOT) in the smartphone market. (Garmin plans to offer a phone based on Google's (NASDAQ:GOOG) Android platform in the near future.) Among all its soon-to-be-rivals, only Research In Motion (NASDAQ:RIMM) currently boasts an operating margin beefier than Garmin's -- and in case you hadn't heard, Research In Motion has problems of its own.

Foolish takeaway
Admittedly, I've got serious reservations about Garmin's entry into smartphones. It's not a core competency, and the competition here is fierce. Mr. Market clearly shares these doubts, pricing the shares at less than five times free cash flow, despite analyst expectations of 13% long-term growth. But if Garmin can make it work, the shares are a screaming bargain at this price.

So go ahead, Garmin. Surprise us.

Fool contributor Rich Smith owns shares of Nokia. Garmin is a Motley Fool Global Gains pick. Nokia is an Inside Value recommendation, Google is a Rule Breakers selection, and Apple is a Stock Advisor pick. The Motley Fool has a disclosure policy.