Hewlett-Packard, Dell Or IBM: Which Is The Best Bet For Now?

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 |  Includes: AUTNF, DELL, HPQ, IBM
by: Timing Best Buy

Introduction

Hewlett-Packard (HPQ)'s acquisition of the British software maker Autonomy Corp (OTC:AUTNF) has been described as one of the worst acquisitions of all time. Investors have been criticizing the acquisition from the beginning. Now, it is known that HPQ did not observe due diligence before such a major and expensive acquisition; in fact the whole story of the acquisition almost reads like a comedy.

When the acquisition was announced, it was considered as another indication that HPQ would be moving from manufacturing computer hardware. Hewlett-Packard and Dell (NASDAQ:DELL) have both tried to diversify away from the computer hardware manufacturing business in the last few years, with different degrees of success. In doing so, they are trying to emulate International Business Machines Corp (NYSE:IBM). Hewlett-Packard, Dell Or IBM: Which Is The Best Bet For Now?

The Financial Performance of This Triple

Hewlett-Packard and Dell are trading at price multiples below the industry average, while IBM is trading at a price multiple above (or close to) the industry average. For example, the average P/E multiple for the industry is 13.9, while the price multiple for IBM is 13.8. The same multiple for Dell is 7.1, and is negative for HPQ (−5.0).

The price multiples seem pretty much justified if we compare the company owners' earnings. Owner earnings are defined as net income + depreciation and amortization - capital expenditure (including working capital). This is a measure similar to free cash flow measures. Is it simply to make money in business for its owners? Owners' earnings for HPQ has been declining for the past few years, while that of IBM has been increasing. HPQ deserves to sell as a cheap stock in the market, while IBM deserves to sell dearly.

Owners' earnings (in millions)

Company

2012 ttm

2011

2010

2009

2008

HPQ

−5613.00

6675.00

8841.00

7972.00

7899.00

DELL

3753.00

3179.00

1918.00

2807.00

2723.00

IBM

13089.00

12301.00

12112.00

11028.00

7967.00

Click to enlarge

Return on invested capital (ROIC, a measure of profitability) has been increasing for IBM, again justifying the higher price multiples. Return on invested capital is calculated as net income / (fixed capital + working capital). The sum of fixed capital and working capital is a measure of the amount invested in the business, and net income is the yield from the business. Thus, ROIC indicates the return dollar that a business invested in is generating.

Return on Invested Capital

Company

2012 ttm

2011

2010

2009

2008

HPQ

−43.17%

42.76%

42.12%

79.57%

52.25%

DELL

36.49%

23.09%

19.19%

32.74%

73.27%

IBM

70.04%

68.80%

49.54%

59.09%

43.50%

Click to enlarge

It is possible to quote many other such financial numbers that will clearly show IBM as the better-performing business among the three. The reason is that IBM earns 85% of its revenue from the more profitable services and consulting business.

The increase in earnings per share over the last five-year period clearly paints a prettier picture for IBM compared to HPQ or Dell. EPS has increased by a higher%age over the period 2007-12.

EPS Growth

Company

2012 ttm

2011

2010

2009

2008

HPQ

−2.81

3.38

3.78

3.21

3.35

DELL

1.9

1.36

0.73

1.25

1.33

IBM

13.25

11.69

10.12

9.07

7.32

Click to enlarge

The breakup of earnings per share shows that HPQ has increased its leverage in the last few years, while Dell has reduced its leverage. Dell has seen a much larger increase in its book value.

Breakup of EPS :

2012 ttm

2011

2010

2009

2008

Asset turnover (sales/assets)

0.95

1.02

1.11

1.01

1.33

Return on sales (NI/sales)

−0.045

0.05

0.068

0.066

0.070

Leverage (assets/net worth)

$3.35

$3.08

$3.09

$2.91

$2.30

Book value per share

$19.53

$19.33

$16.03

$16.32

$15.50

Click to enlarge

Breakup of EPS :

2012 ttm

2011

2010

2009

2008

Asset turnover (sales/assets)

1.39

1.59

1.57

2.31

2.22

Return on sales (NI/sales)

0.0563

0.0431

0.0271

0.0406

0.0482

Leverage (assets/net worth)

$4.99

$4.97

$5.97

$6.20

$7.38

Book value per share

$4.85

$3.98

$2.87

$2.15

$1.69

Click to enlarge

The dividend yield of IBM has been steady over the last three years. However, it should be noted that Hewlett-Packard has also maintained a steady dividend for the last five years. HPQ currently provides a dividend yield of 3.77%, which is almost twice the present yield on 30-year, AAA-rated bond (1.97%). Cash flow generation for HPQ has been strong, and has remained so this year. Hewlett-Packard generated $4 billion in operating cash flow during the fourth quarter, and $10.6 billion in cash during the year as a whole. In fact, Hewlett-Packard has been able to generate enough money to pay off some of its debt.

Dividend yield

Company

2012(current)

2011

2010

2009

2008

HPQ

3.77%

0.93%

0.62%

0.95%

0.68%

DELL

1.60%

0

0

0

0

IBM

1.74%

1.52%

1.67%

1.86%

1.30%

Click to enlarge

IBM's focus these days is software and consulting; hardware is only 15% of its business. Hewlett-Packard and Dell will try to make a similar switch. DELL is ahead of HPQ in trying to switch strategy, as services and consulting make up 31% of its sales. In comparison, HPQ only aimed to achieve 9% of sales from software by 2015, and it is unlikely that it will achieve even that. All sorts of scenarios are possible in the future. Both Hewlett-Packard and Dell are presently trying to shift focus from PC and hardware to software, services, the cloud and enterprise. One should remember the probability that both may be on the road to nowhere.

HPQ DELL IBM

Current Price

$13.68

$9.97

$189.88

Estimated Fair Value Range

N/A

$22-$28

$237-$256

Stock Valuation

N/A

Undervalued

Undervalued

Upside Potential to Reach a Fair Stock Value

N/A

124%

25%

Click to enlarge

Data as of December 29, 2012

The discounted earnings plus equity model, developed by EFS Investment Partners and applied to the three competitors, suggests the following: currently two stocks (DELL and IBM) are undervalued. In addition, EFS's fair stock price valuation indicates that Dell stock is trading at a considerable discount.

Summary

IBM has much sounder fundamentals compared to Dell and Hewlett-Packard; however, it is difficult to arrive at an accurate value for the company. DELL and HPQ are the types of stocks many investors will not touch (those who want to invest only in good companies at decent prices). Qualitatively, there may not be much to choose between HPQ and DELL. However, if you are looking for bargains among companies whose prospects are uncertain in the long run, the case for Hewlett-Packard with a short-term horizon is stronger, because of a relatively lower valuation, better dividend yield and sound cash flow generation in the recent past, as well as sound prospects for generating cash at least in the near future. Dell's current price dip is a small window of opportunity to purchase the shares before the stock continues its upward ascent.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.