The latest earnings results from Hewlett-Packard (NYSE:HPQ) received a favorable response from the market, with a nearly 15% rally that put the stock back toward its highs for the year. Most of the optimism was based on the company's improved profit outlook but when we look at the wider trends in HP's key businesses, there are reasons for skepticism. Furthermore, some of the data points were less than encouraging and the argument can be made that the positive market response came as the result of nothing more than an improvement on weak expectations. The stock has risen by more than 75% year-to-date, and the relative weakness in the company (and in the broader PC industry) means it is time to sell the stock.
HP's earnings release showed that revenues were lower by 10%, as the well-documented slowdown in PCs cut into key areas of the company's business. Competition to cut product line costs has been initiated by new sales strategies at Dell (NASDAQ:DELL) and this has contributed to the recent weakness. On the positive side, the company has managed to reduce its debt and raise its yearly forecasts in free cash flow. HP expects earnings of 84 to 87 cents for the fiscal third quarter, up from the previous market estimates of 83 cents per share. But do these positives truly outweigh the negatives?
A Look at the Numbers
HP's quarterly net income dropped by 32% (to $1.08 billion), and came in at 55 cents per share, for the fiscal second quarter. This is a drop from the $1.59 billion (80 cents per share) seen in the previous year. The 10% drop in revenues created a result of $27.58 billion for the fiscal second quarter. So the current results are not as rosy at second glance. More problematic for the company, however, is the state of the PC industry itself.
A 14% drop in PC sales for the first quarter has already led to massive earnings miss at Dell, and similar results were seen at HP as well. Laptop sales make up the biggest portion of HP's PC division, and quarterly figures showed sales declines of 24%. The company recently installed Meg Whitman in the role of CEO, the fourth leadership change in six years. The company is clearly in a transitional period, with increased competition from companies like Dell creating the need for new strategies in alternative business segments (such as in cloud computing and mobile devices). This leaves the stock highly vulnerable, and with market valuations seen at elevated levels, it is time to sell HPQ.
The fundamental difficulties HP has seen in growing key areas of its business are matching up nicely with rallies to new yearly highs in creating opportunities for selling. The longer-term downtrend can be seen clearly in the chart below and on a medium-term basis, risk-to-reward ratios also favor sell positions in HPQ:
As a comparative example, key competitor DELL is facing similar price rallies. This creates another opportunity for sell positions in a trend that is now becoming obvious more broadly within the industry:
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.