PalmOne's Smart Bet
The pioneer of the PDA has bounced back thanks to the success of its Treo smartphone. But is there enough growth ahead for investors who buy the stock now?
By Paul R. La Monica

(MONEY Magazine) – WHY IT'S HOT

Personal digital assistants are no longer the cool gadget du jour. According to tech research firm IDC, handheld sales in the second quarter of 2004 dipped 1% from a year earlier. Big players, including Sony, have recently decided to get out of the business in the U.S. So how is it that shares of PDA maker palmOne (PLMO) are up nearly 150% in 2004? Because the company isn't just in the PDA business anymore.

PalmOne, which was created from the 2003 merger of Palm and its former nemesis Handspring, has found a way to successfully capitalize on the next big thing in consumer electronics: the smartphone. Thanks in large part to the popularity of its Treo 600, a combination phone/messaging device/Web browser, palmOne's revenues in the first quarter of fiscal 2005 surged 62% from a year earlier. The company reported a profit of 38¢ a share, compared with a loss of 57¢ a share in the same period last year.

Wall Street pros who had doubted palmOne's ability to catch the smartphone wave have now been won over. According to Thomson First Call, at the beginning of 2004, analysts were predicting a loss of 3¢ a share in fiscal 2005 (which ends next May). Now analysts are forecasting a profit of $1.76. "There has been a positive transformation from the slower-growth, lower-margin handheld business to the faster-growth, higher-margin smartphone business," says Christopher Versace, an analyst with Friedman Billings Ramsey.


Where to start? With a market value of just $1.3 billion, palmOne is still a small company, and its growth is driven largely by one product. The traders who pushed this stock up so fast want palmOne to keep posting blowout numbers, and that's going to be increasingly tough now that expectations are higher. So when palmOne said in September that it expected sales and profits for its second quarter to be substantially better than the same period last year—but not as high as analyst estimates—shares sank 15% the next day.

Look for competition in the smartphone market to get hairy. In addition to Research in Motion, maker of the BlackBerry, palmOne faces threats from Motorola, Nokia and (there's that name again) Sony, which is muscling into smartphones through its partnership with Ericsson.

Darcy Travlos, an analyst with Caris & Co., thinks that some of these fears are overblown because even though palmOne may have to fight for market share, the whole sector still has lots of room to grow. According to IDC, smartphones accounted for only 2.4% of the worldwide mobile-phone market in the second quarter. Travlos thinks the Treo is the iPod of the smartphone market, a device that may ultimately define the category.

PalmOne's P/E ratio is 17 based on earnings forecasts for the next four quarters. That's riskier than it looks, considering how often small companies fall short of expectations. But it's lower than rival Research in Motion's P/E of 37.

NOTES: Based on forward four-quarter estimates. As of Oct. 20. SOURCE: Thomson/Baseline.