Can Nokia Answer Higher Profits Calls After Hanging Up Phones?

NEW YORK (TheStreet) -- With Nokia (NOK) stock down nearly 40% over the last five years, investors wanted a reason to believe in management's long-term commitment to reinvent the company.

Leading up to its second-quarter earnings results Thursday there were questions whether Nokia made the right decision to exit its handset business. Apple (AAPL) and Samsung (SSNLF) left it no choice. But by beating analysts' profit revenue and estimates and offering a rosier-than-expected outlook, Nokia answered the call.

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Shares are trading around $8, up 1.4% for the year to date. Investors want to know to what extent can management complete this transformation and become a network-focused company. More important, will it be profitable?

Nokia is no longer Wall Street's punching bag. The company now has a more attractive business -- one that is easier to understand. But the stock's no longer cheap. Shares are trading at their 52-week high. At a price/earnings ratio of 27, investors need to be more careful. Even on next year's estimates of 39 cents per share, these shares are still expensive at a P/E of 21.

With second-quarter profits rising 20% year over year, investors don't care. But things are not as they seem. This quarter had a lot of moving parts that won't be duplicated.

Revenue of 2.94 billion euro ($3.99 billion) topped Wall Street's expectations of 2.93 billion euro ($3.94 billion). Although this represented a 7% year-over-year decline, it also reflected 10% sequential jump.

Investors understood the 7% decline was due to the company's new focus towards its network business, following the sale of its Devices & Services group to Microsoft (MSFT). This means the network business now accounts for 87% of Nokia's total revenue. And this is where investors have to understand the risk/reward tradeoff in Nokia's stock.

First, it was never a matter of "if" Nokia would exit its handset business, it was a matter of "when." Management understood it was their best chance for long-term survival. Microsoft, which bought the handset business for $7.2 billion, was the clear and obvious choice.

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But with the network segment now accounting for close to 90% of its business, Nokia must execute to perfection to keep its head above water. It can't afford anymore bad quarters. It's either that or it has to become better diversified.

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