HP (ticker: HPQ) recently popped up in a couple different places I normally look for stock ideas, and so I wanted to take a deeper look.
Magic Formula
One place I go looking for stock ideas is Joel Greenblatt’s Magic Formula website. The website looks for good companies (high ROIC) that are inexpensive (EV/EBIT).
The screener lets you select the minimum market cap. Smaller companies tend to dominate the list if you leave the Market cap at the 50 Million. HPQ jumped out at me because it was one of two companies over 10 billion on the list.
Berkshire Hathaway’s 13F:
The second place I noticed HPQ was when I was looking through Berkshire Hathaway’s 13F. Warren Buffet bought a bunch of shares ($3.7 Billion) in Q1 2022. The average price paid was estimated to be $36.94, current price is much lower at the time of writing ($25.1). The low price during the period was $34.07, so there is no way Buffett got as good a deal as we could today.
Analysis:
I took a look at the company’s growth and return on invested capital (ROIC). Seems like HPQ has been crushing it in the last 5 years. The Book Value per share is negative though, which jumps out a little bit.
Looking back through the companies 10K’s, it spun off HPE, which was there enterprise services and software business unit. This represented about half of HP’s revenue.
In the process of the spin-off, a lot of the equity went over to HPE.
HPQ’s book value has stayed low after the fact because the company has basically returned all earnings to shareholders. They have returned capital through a growing dividend and share repurchases, rather than warehousing the earnings on the balance sheet. The average returned capital averages around 100% since the spin-off. This makes the company share holder friendly and explains Buffett’s interest.
The share repurchases also explain the High ROIC and growth on a per share basis. Share repurchases aren’t subtracted from income (numerator for ROIC), but are removed from capital invested (denominator). I took another look at total revenue and earnings growth and the results are a little more muted at roughly ~50% of the per share growth rates from before.
What does all this mean? I don’t think you could argue that HP has an obvious qualitative durable completive advantage or “moat”. The computers it sells could just as easily come from Dell. The printers could just as easily come from Canon. HP is number one or two in those categories for market share, but it doesn’t have a brand advantage.
All that said… it could still be under valued or have a non-obvious moat. An example might be switching costs for printer cartridges. Once you have bought the printer, you might need HP’s cartridges. Given all this, I wanted to take a stab at the valuation.
Comparison against Peers:
I took a look at Dell to see how HP stacked up. Between the two, I would definitely prefer HP. It has a lower price earnings multiple, has been profitable for the past decade (unlike Dell), beats Dell on growth, and it has better capital returns. The growth numbers look even better on a per share basis for HP because Dell does not pay a dividend or do major share repurchases.
HP seems cheaper and better than Dell.
Estimated Value with DCF:
Let’s assume that HP’s revenue growth rate continues at just over 6%. If we also assume the PE ratio jumps up closer to its historical mean of 6.5x, I come up with value of $31.5 and a 20% MOS (using an 8% discount rate). I think this is probably a reasonable and conservative base case. It values the company just below where Buffet bought in, and the growth rate matches up with the expected market growth rate plus “typical” inflation.
If we take the growth rate up to 14.5% to match the revenue per share growth rate, we end up with $67.5 and a 60% MOS. This is probably a bit of a stretch for HP, but it gives a feel for where the ceiling is.
If the growth rate drops to 0% the floor looks like $17. This is probably extreme. The EPS should continue to grow as they do share repurchases, and you collect the 3.5% dividend along the way.
Conclusion:
HPQ seems undervalued with the potential for upside, but it isn’t a screaming bargain for me given its lack of an obvious moat. I am going to add it to my watch list to see if it drops further. Additionally, I might try to do some more research to bolster my industry understanding and look for a hidden advantage. If you enjoyed this article, feel free to “applaud”, and you can follow me on Medium or sign up for emails to be notified of more stories like this.
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Disclosure: I may enter a beneficial long position in the shares of HPQ either through stock ownership or options.
Note that this article does not provide personal investment advice and I am not a qualified licensed investment advisor. All information found here is for entertainment or educational purposes only and should not be construed as personal investment advice.
