How to Profit While Traders Flee HP’s Stock!

Shine 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 trying to make a comeback. HP is developing a series of new hardware devices which include tablets, laptops and printing solutions. However these new babies are still a few months away from hitting the market.

As for the current situation, HP is more or less in a soup. The PC business has been falling and the competition is getting tougher. Gartner says that the Worldwide PC shipment declined 8 percent in the third quarter of 2012. Another piece of bad news for HP, according to the research carried out by Gartner in Worldwide PC shipment, is that Lenovo took the lead over HP for No. 1 in global position.

However, according to another report by IDC, HP still holds the number 1 position in Worldwide PC shipments.

HP's response to this was that “While there are a variety of PC share reports in the market, some don’t measure the market in its entirety. The IDC analysis includes the very important workstation segment and therefore is more comprehensive. In that IDC report, HP occupies the No. 1 position in PCs.”

Whatever the case may be, No.1 or not, what we can definitely say is that HP's profit is shrinking. We know, last week, HP announced a far steeper-than-expected drop in profit for 2013, which resulted in the share price falling to a nine-year low.

One can wonder if a 70 year old company, that is expected to report revenue of more than $100 billion and operating profits of nearly $7 billion next year, is worth buying at a price-to-earning (P/E) ratio of 4. But then we can leave that decision to the most devout value investors for now. For teh rest of us there is a safer way to earn from HP.

We always knew HP, primarily, as a Hardware company. But HP no longer wants to remain in the Hardware business alone. We have seen the company venturing into Enterprise services. Maybe HP is following the footsteps of IBM (NYSE: IBM). And maybe in another few years we see HP becoming the next IBM. IBM is a tech behemoth, which had lost its investors confidence in the early 1990s. It was only after Lou Gerstner took charge of the company and overhauled the company’s image from being just a dead hardware manufacturer to a successful multinational technology and consulting corporation, that the share price of IBM started increasing and later delivered a gain of more than 1200% in six years.

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However, just because HP is following the IBM way we cannot say for sure that HP will have a bright future. 

<img src="/media/images/user_13585/xerox_large.jpg" />


HP could also end up like Xerox corporation (NYSE: XRX). Xerox is an American multinational company that was primarily a hardware manufacturer in the past providing printing and photo-copying solutions. Xerox later got into IT services, business consulting and outsourcing. However getting into the services sector did not help the falling share price of Xerox. The share price of Xerox fell on hard times and never recovered.

<img src="/media/images/user_13585/hp_large.jpg" />


Just like IBM and Xerox, the long term chart of HP shows a steep decline. However this stock could still be appealing to value investors. Even though HP is selling at a price less that the company’s book value, it has enough cash flow to maintain its dividend, pay its debt and still meet its operational needs.

Though this reflects positively, it is unlikely that investors can expect a large short-term gain. At the same time one can also say that there is not much downside left in the stock. We can also expect the company to report an EPS of $2.10 to $2.30 next year with operating earnings of about $3.40 to $3.60 a share. Given these expectations the stock can recover eventually and in time we can expect the share price of HP to increase accordingly.

Whle there are several ways to profit from this, selling puts for the stock may generate a handsome reward. Last week HP closed 14.36% down at $14.73. There won't likely be any more news before the announcement of the earnings on November 20, a few days after the November options expire on November 16. In the past we have seen traders generally expect the share price of the company to bounce back after a deep dive. Hence the November 13 puts appear to be a low-risk sell. We can also expect the strike price to fall further which is 11% below the current price. Currently these options are trading at around 21 cents and if they expire worthless, traders can expect a return of about 8% on a fully margined position in about six weeks. If the share price falls below $13, the trader can own the stock for $12.79 ($13 strike price minus $0.21 premium collected), or 3.7 times next year’s operating earnings. This would result in a dividend yield of around 4.1% which would be a good income investment. However the chance that shares will fall below $13 is slim, in my opinion.

Suggestions for the Trade:

Sell HP's Nov 13 Puts at 30 cents or less without a stop-loss. If HP closes at a price greater than $13 at expiration, the puts will expire worthless and you pocket the premium. If HP closes below $13, you will buy the shares at a low price and have a chance to enjoy long-term gains in this company.

shinerulz has no positions in the stocks mentioned above. The Motley Fool owns shares of International Business Machines. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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