The Strongest “Value” Buy in Today’s Stock Market
Paul is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Hewlett-Packard (NYSE: HPQ) is by far the most interesting and misunderstood “value” play in the stock market. Last week’s earnings announcement and revelation of allegedly “fraudulent” accounting at the Autonomy unit purchased in 2011 (before it was acquired) was a final, throw-in-the-towel moment for frustrated investors in HPQ. A Motley Fool Blog Network post by Anh Hoang gave a good recap of HPQ’s hurdles faced during the year.
Hewlett-Packard’s stock price has steadily declined from a variety of leadership and business development problems for several years, from a high of $49 a share in February 2011 to $11 last week. This crushing 78% drop in price has totally shattered investor confidence in the organization and its future, regardless of underlying facts.
Chart courtesy of StockCharts.com
No doubt, the emergence of smart portable phones and tablets, alongside new electronic devices is eating into Hewlett’s leading personal computer (PC) sales, and the company has struggled to find a growth engine for investors beyond its traditional flagship printer business. Other macroeconomic factors like a stronger U.S. Dollar the past year and a weakening global economy for end sales have also dragged down the results of HPQ.
You have to ask and answer several basic questions for yourself before investing in Hewlett-Packard at this stage, as a value investor. If Hewlett was honestly operating at a loss and its products were truly headed for obsolescence, we would want to avoid HPQ at all costs. Here are the Quantemonics Investing answers to some basic questions:
Does Hewlett-Packard have an uncertain, difficult to forecast future from declining PC sales and a high level of liabilities? YES
Did HPQ overpay for recent acquisitions away from its core printer business? SURE
Will consumers and businesses buy PCs in the future? YES
Will consumers and businesses buy printers in the future? WITHOUT DOUBT
Will end users buy such equipment from the “leading” brand name manufacturer and retailer of computer products on the planet? ABSOLUTELY
In our opinion, short sellers, naysayers, jump on the bandwagon trend followers, and disgruntled investors giving up on Hewlett-Packard are completely ignoring the true underlying value of HPQ’s business operations going forward; and, going forward is what successful stock market investing is ALL ABOUT. Some of the top long-term investors on the planet have been accumulating HPQ stock the last 9-12 months at much higher prices than available today. Primary in my mind, one of the most successful “value” investors accumulating HPQ has been Ray Dalio (a better risk-adjusted investor than even Warren Buffett the last several decades). If Mr. Dalio was willing to buy HPQ at $20, what do you think his view of $11 or $12 would be right now?
Before you shoot off a wise remark to answer that question, consider Hewlett-Packard actually BEAT non-GAAP EPS estimates by 2 cents last quarter, and is holding earnings per share guidance for fiscal 2013 at the same non-GAAP $3.40-$3.60 level as expected a few months ago! If HPQ has reached a bottom in both its underlying business problems and investor “expectations” about its future, what are you purchasing for $12 a share? If you could purchase the entire company, on every $12 paid upfront, you are getting $3.50 in after-tax earnings annually (30% in your pocket next year) and actual cash flow of almost $6.00 per share each year (50% back in cash flow during 2013), with the honest potential for both to GROW each year the rest of your life, if operations are at an inflection point.
Hewlett is the antithesis of buying Apple or Facebook or Google at annual EPS multiples of 15-20, and cash flows of 8-15x. While these stocks are considered “sure bets” for investors with only blue skies ahead for their businesses, they are priced at higher valuations reflecting this sentiment. In comparison, nobody in their right mind thinks HPQ will make it past tomorrow, and you can purchase the company’s income producing assets at 3x EPS and 2x operating cash flow. [Nobody said investing was EASY! If it were, everybody would be rich!]
The ONLY way a stock gets this cheap on basic valuation multiples is after a multi-year run of problems combine to scare every weak-in-the-knees investor out. Using the word “fraud” in your press release is a surefire way to get the financial press into attack mode. The press (legitimate mainstay reporting and amateur bloggers alike) have unleashed perhaps the greatest amount of trash talking AGAINST Hewlett-Packard’s stock price, the board of directors and upper management of any situation I have witnessed during my 26 years of investing! You would think HPQ was just days away from filing bankruptcy based on the negativity of reporting, not returning $11 billion annually in earnings and operating cash flow to its owners!
Dell (NASDAQ: DELL) is Hewlett-Packard’s biggest competitor in the global PC and printer market, and is facing similar headwinds to its business model as Hewlett. Quantemonics sees strong value in Dell shares also, but so far we have only purchased HPQ for our own accounts and those mirroring us on Covestor.com. Considering the breadth of business units and ability to reshuffle them, we feel HPQ is a better risk-adjusted proposition at current levels.
Under asset “break-up” analysis, Hewlett-Packard’s value today is quite high, in the $25-$30 per share range as an added bonus to buyers around $12. Despite all the problems and declining short-run prospects for some of its divisions, HPQ has a long list of valuable assets, product lines, patents, plant & equipment, etc. that could be sold piecemeal after a takeover or through a massive restructuring. We suggest investors do their own due diligence and ignore the prevailing news headlines of the moment by reviewing HPQ’s latest 10-K filing with the SEC.
I remember at the end of the housing bust in 2009, conventional wisdom held America would never build another home, or apartment, or condo AGAIN. At that point the entire furniture industry, publicly-traded, market capitalization was just $1 billion. Investors priced businesses manufacturing and selling furniture at this emotional moment in time as though nobody would sit down in a new chair or sleep on a new mattress EVER again. Sounds foolish looking back, as I quizzed investors on this point and got the same response in 2009 – YES, furniture sales were done and would NEVER come back! I disagreed and personally purchased shares of La-Z-Boy (LZB) in early 2009 between $0.60-$2.00 and rode them back toward $10 less than six months later, as fear subsided and rational analysis returned.
We have been asking ourselves the same about PCs and printers during 2012, and our answer is the opposite of mainstream thinking currently. Contrary to the world ending for computer makers, Quantemonics Investing believes regular and laptop PCs, and Hewlett’s bread and butter printer business have decent long-term futures. Fear has so clouded people’s judgment, that only the latest stock quote and press release are important, not the actual facts on the ground. We rate HPQ a Strong Buy and purchased shares under $12 last week. In our opinion, the stock trading cycle of moving share ownership from weak hands to strong is now complete.
FULL DISCLOSURE: We hold Hewlett-Packard (HPQ) shares long in our mirror portfolios on Covestor http://covestor.com/quantemonics-investing/relative-value and unrelated personal accounts. We do not currently hold positions in any other stock mentioned in this article. Quantemonics Investing, LLC is paid as a general publication information and data provider. All contents of the Quantemonics Investing service and blogs on the Motley Fool website are provided for information and education purposes only. You agree that the service is not to be interpreted as investment advice, as an endorsement of any security or investment, or as an offer or solicitation to buy or sell any security. Quantemonics, www.quantemonicsinvesting.com and the owners and officers of Quantemonics Investing, LLC do not provide specific and personalized investment advice, and are not registered as investment advisors or a broker/dealer. The trading of securities or investments may not be suitable for all users of the service. It should not be assumed that future results will be profitable or will equal past performance, and all readers should understand each security investment involves a degree of risk. Investors should not assume that profits or gains will be realized by any security or investment mentioned by the service or related blogs. Readers accept any and all potential liability, loss, expense and cost when making trades or investments in their own account. We recommend readers consult with a registered financial adviser before making any investment decision. Investors should not hold more than 5% of their portfolio capital in any single equity position, as a general rule of diversification. No compensation of any kind has been paid to Quantemonics Investing, LLC or related parties for company participation in our data service. The facts and information presented have been obtained from original or recognized statistical sources believed to be reliable, but their accuracy and completeness cannot be guaranteed. All opinions expressed on the service are subject to change without notice. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Dell. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!