Are These Tech Stocks Value Traps?

David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I have never been an advocate of shorting stocks. The reason stems from the notion that you are inherently betting against inertia. With that said, there are opportunities when a stock is positioned to drop. One of the riskiest sectors to short is technology, since growth is largely speculative in that area and often a function of short-term emotion. In this article, I look at two tech companies, once Wall Street darlings, now viewed by many to be "value traps."

How Hewlett-Packard (NYSE: HPQ) Is Reforming

Hewlett-Packard is a tech firm that specializes in producing hardware and software. Commonly known as HP, it was the biggest PC manufacturer in the world until 2012 when it was overtaken by Lenovo, a PC company based in China. HP is a trusted brand in the manufacturing of personal computers, industrial servers, storage gadgets, printers and the software that goes with these products. The company further offers consulting services for the vast majority of its products. In 2002, it joined forces with Compaq and acquired EDS leading to a joint income of $118.4

HP has acquired several other companies in the past which include 3Com in April 2010, Palm in April 2010 at the price of $1.2 billion and 3PAR in September 2010 for $2.07 billion. But unfortunately this growth-through-acquisition strategy hasn't always been smooth. After announcing a 31% decline in profits in mid-2012, HP disclosed that it was accusing Autonomy, a UK software producer HP bought for $10.3 billion, of accounting fraud. Management insists that Autonomy not only inflated its value through accounting tricks but also failed to disclose and even misrepresented financials--a claim it asked the Department of Justice to investigate. In November, HP wrote down $8.8 billion, $5 billion of which was related to the Autonomy scandal.

In an attempt to reform the business, the company has effectively moved in the opposite direction of acquisition by downsizing. From laying off 27,000 employees to explicitly expressing an interest in spurning divisions, management is trying to de-risk its business. Certainly, shareholders have become disillusioned into what is increasingly being seen as a "value trap": in the last two years alone, the company saw its share price decline from around $50 to less than $20 today. But the free cash flow yield is now at at a terrific 24%. In the last three years, the company has bought back shares worth $26 billion, and, when you add in a 3.3% dividend yield, the downside looks limited in the long-term.

Is Intel (NASDAQ: INTC) a Value Trap Too?

Intel is also becoming associated with a "value trap." Despite having 15.9% of the market in 2011 and trading at 9.6x past earning, the bear sentiment is clear: 25 of 41 reporting analysts rate the stock a relatively pessimistic "hold." Even still, 16 call it a "buy" or better, six of which say "strong buy." Though shares have risen 14.4% from the lows, the stock is still down 23.4% from the 52-week high. So what to make of the company?

A favorable feature of Intel is its vertical integration. This means that, unlike other chip making companies, Intel does not primarily use third-parties to outsource manufacturing. Instead, it does everything in-house and has put significant emphasis on upcoming technologies in manufacturing. 

But vertical integration goes both ways: Customers may not need your own products if they can more efficiently create their own. Apple (NASDAQ: AAPL) acquired ARM license and can now produce some of the best mobile processors. This means that Apple won’t need Intel’s Atom product(s) anymore. This situation is further worsened by the fact that Apple has all the resources it requires to manufacture its own specialized chips. And I do not believe the electronics business will be very desirous to start buying Intel's chips in the long-term, since the company prides itself in having everything produced by Apple and for Apple (those interested in purchasing a MacBook, for example, know the typical employee pitch.) When you add in the downside from reduced demand for personal computers as people shift to smartphones and tablets, you have what looks to be like a perfect storm.

However, this market attitude has largely been articulated. Investors should thus look at whether there will be upside to the general expectation. In my view, there is. For one, multiples are too low and should they even expand to 13x (and Intel is not dying any time soon), there is 14.6% instant upside on top of a 4.1% annual dividend yield. I recommend buying to take advantage of this opportunity.


TakeoverAnalyst has no position in any stocks mentioned. The Motley Fool recommends Apple and Intel. The Motley Fool owns shares of Apple and Intel. 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. This article was written by the staff of TakeoverAnalyst, which does not intend on opening a position in the next 48 hours.

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