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Is it Time to Buy Hewlett-Packard (HPQ)

Published on April 17, 2012

Is it Time to Buy Hewlett-Packard (HPQ)

April 17, 2012

So, you missed the rally that began since Mar 2009?

Hewlett Packard Company HPQ as of yesterday closed at $24.31, a level last seen during Mar 2009 when markets were almost at the lowest level of the past decade. Will you buy it now? In this post, I am going to share my both value and technical investment takes. Finally, I shall share some ideas on how options can be used to hedge and/or to lower your cost.

VALUE TAKE:
Based on my analysis using discount cash flow models, I think Hewlett Packard HPQ is undervalued. The selling pressure is driven by recent lackluster performance and uncertainty around company’s future. It is going through tough times and there is no clear direction emerging thus depressing stock value even further.  Let’s get into the numbers.

Click here to learn how to Value Stocks and here for an example of a company that was later purchased)

  • Assuming 0% growth going forward, using last 10year normalized average earnings of $2.07 (last 3 years is $3.38) my value target price comes to roughly $17.6, and assuming just 1.5% growth my derived intrinsic value is 23.8 vs. current share price of 24.3 which is just 0.4x sales and 1.2x book value. (Assumption 2.128 billion shares outstanding).
  • If I take FY 2010-11, 8.1billion owner’s earnings* (approximated by free cash flow), use 0% growth and discount using 10% Weighted Average Cost of Capital (WACC), the intrinsic value is roughly $30. If there is any growth above 0, say same as expected US GDP of ~ 2% and discount it using 10% WACC, the price can easily move to almost $37.

(What is Owner’s earnings-> It is Net Income+Depreciation+Amortization+One time Savings-One time expenditures-Capital Expenditures)

  • However, If you factor analysts’ estimates of long term growth as ~4% and discount it using 10% WACC, share price intrinsic values jumps to $45+
  • You could dress-up the numbers as you like, but even after assuming 2 to 3% decline for next 2-3 years and then return of growth to roughly 2%, it will still give you value higher than current prices.

Watchout – Of course, It is not yet a bargain in traditional “margin of safety” way and HPQ may just not sustain its competitive advantage going forwards. It may also not be able to reinvent itself. It may see business decline continuously. Those are clearly risk factors associated with the purchase of stock. Value investing is done when almost all others are fearful. The key is though is to “value” correctly.

Above analysis is by no means the most accurate analysis of HP’s value, but at least it points you towards an idea that’s screaming for attention.

TECHNICAL TAKE-
Here is HPQ’s 20 Year chart. Currently it is trading below financial crisis levels and quite closer to a major support line (click to enlarge)

Is it time to buy Hewlett-Packard (HPQ)? Prophet Charts

Though there is a potential for an undercut of the trendline, even from a technical perspective I would be a buyer around $20-$24 zone. I don’t buy at a single price but almost always scale into a position.

How could you use options to either hedge and/or lower your cost.
There are couple of ways to play this-

  1. One can buy shares and buy ATM puts to hedge it.
  2. One can by shares, buy ATM puts and sell OOM calls to finance purchase of puts to create bracket and limit the gains. Keep repeating it if HP either continues to rise or fall or till it hits your stop loss.
  3. One can sell naked puts, if assigned buy shares, sell puts again and write calls to make money from either side movement.
  4.  One can buy simple straight ITM (or OOM) leap calls
  5. The options’ possibilities are enormous, there are still many more ways to play bullish bias with defined risk and higher leverage (i.e. credit spreads, calendars, etc.)!!!

Bottom-line– I will be buyers as per the scenarios mentioned above. As of this writing, I don’t have any long positions in HPQ but I may initiate and close any time.

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