Source: PaxForex Premium Analytics Portal, Fundamental Insight
HP's stock price rose 15% to a 52-week high last week after Berkshire Hathaway announced a new $4.2 billion investment in the company. The purchase gives Berkshire 11.4% of HP and makes it its largest shareholder.
This is an excellent announcement for HP investors, but is it too late for other investors to step in after Berkshire's big purchase? Let's take a look at HP's business, how it lines up with Berkshire's investment strategies, and whether those stocks have the potential to grow after more than doubling in the past three years.
In 2015, HP spun off its enterprise business as Hewlett-Packard Enterprise. After that, the "new" HP sold only PCs, printers, and printing supplies in the consumer and commercial markets.
HP originally fought with limited demand for its PCs as consumers switched to smartphones, tablets, and convertible devices. But under the leadership of Dion Weisler, who served as HP's CEO from 2015 to 2019, the company revitalized the dormant PC business by developing new models of high-end notebooks, convertibles, all-in-one computers, and gaming desktops.
The printing business also struggled at first because of long refresh cycles, competition from ink and toner suppliers, and the growth of paperless workplaces. But Weisler took care of the printing business by launching a cost-effective cartridge subscription service, scaling it up by acquiring Samsung's printing business and office equipment dealer Apogee, and developing a new line of industrial 3D printers.
When Weisler handed over the reins to current HP CEO Enrique Lores, the company's core businesses were again showing slow but steady growth.
But in fiscal 2020, which ended in October of the calendar year, the company again faced a slowdown in growth as businesses shut down during the pandemic and suspended new device upgrades. The company partially softened the blow by selling more consumer PCs and printers for people working remotely and creating do-it-yourself projects at home, but its revenue still fell 4% for the full year, and adjusted earnings per share (EPS) rose just 2%.
Things enhanced greatly last year as more businesses resumed operations. The acceleration in the commercial business also offset the slowdown in the print business after the shutdown, and total revenue and adjusted EPS grew 12% and 66%, respectively, for the full year. Experts believe that revenues and earnings per share will grow 4% and 13%, respectively, in 2022.
Warren Buffett typically favors cash-rich companies that return most of their free cash flow (FCF) to investors through large buybacks and dividends. HP has returned more than 100 percent of its FCF to investors over the past two years, even as its commercial business has suffered pandemic-related disruptions.
In addition, share buybacks have reduced the number of shares outstanding by 30% over the past three years, while the share price has risen by more than 100%. This indicates that the company is not just using share repurchases to offset dilution from stock-based compensation plans and that its purchases were timely.
Apple, Berkshire's largest stake, has also cut its stock by 11% in the past three years, while its share price has risen nearly 240%.
HP management believes its FCF will increase to "at least" $4.5 billion in fiscal 2022, and more than $4 billion of that will be spent on stock buybacks. As for dividends, the company currently pays a high prospective yield of 2.9 percent, and it has raised that payout every year since it split with HPE.
As of this writing, HP stock is still trading at eight times the forward earnings ratio. By comparison, Apple has a ratio of 30.
HP stock is cheap because analysts expect the slowdown to continue as the remote work trend wanes, chip shortages linger, and the company prepares for another long cycle of PC and printer upgrades. Inflation, lower consumer spending, and other macroeconomic factors could also reduce the market's appetite for its products shortly.
But Warren Buffett said: "Whether it's socks or stocks, I like to buy a quality product when it's discounted." HP prices are declining because investors expect a slowdown in near-term growth.
However, HP faces only a cyclical, not secular, slowdown. HP's PC and printer sales may fluctuate based on hardware refresh cycles, but the company will continue to generate plenty of cash for stock repurchases and dividend payments. These shareholder-friendly measures, which probably attracted Berkshire, indicate that it's not too late to buy the company's stock.
As long as the price is above 34.74, follow the recommendations below:
- Time frame: D1
- Recommendation: long position
- Entry point: 38.43
- Take Profit 1: 41.34
- Take Profit 2: 43.00
Alternative scenario:
If the level of 34.74 is broken-down, follow the recommendations below:
- Time frame: D1
- Recommendation: short position
- Entry point: 34.74
- Take Profit 1: 32.74
- Take Profit 2: 30.20
