Since December, Hewlett-Packard (HPQ) has rallied an astounding 100%. This gain in share price has added over $20 billion in value to shareholders and has led many to speculate that the worst is past. In this article, I will impartially examine the fundamental history of Hewlett-Packard and provide a bearish recommendation for the security. Rather than relying on my opinion or interpretation of news events, I will instead quantitatively analyze historic returns.
A History of Returns
In order to fundamentally analyze Hewlett-Packard, I have relied heavily on return on assets. Return on assets is calculated by taking the average total assets across an operating cycle and dividing it by the net income of the firm. The usefulness of this metric is that it allows an analyst the ability to measure how efficiently a firm is using its assets to generate profits. Since HPQ is a technology company with a diversified asset base, when we study return on assets, we are comprehensively studying the overall performance of the firm. The study of return on assets allows us the ability to fully examine all of the profits (or losses) from each business endeavor in light of the asset base required to generate these profits. In the chart below, five years of return on assets for Hewlett-Packard can be seen.
The chart above tells a vibrant story of economic history in the life of HPQ. In order to understand this story, I have isolated several key economic time periods in the points below. Beneath the bullet points I have included a chart showing the discussion.
- The first period of time, which we will study is from the second quarter of 2008 until the first quarter of 2009. During this time period, economic storms were impacting the entire world and HPQ was not sheltered from the tempest. Organizational returns decreased by around 30% and profits eroded from the financial statements. Shareholders, seeking both a shelter from the economy and a preservation of capital from a declining firm, exited shares driving price down 24%.
- The next period of distinct economic history is from the second quarter of 2009 to the second quarter of 2010. During this period of time, Hewlett-Packard experienced a very gradual recovery in its return on assets. What this tangibly means is that HPQ was able to shrug off the damage of the financial crisis and slowly began to generate greater profits from its asset base. Investors seeking yield became attracted to the growth prospects of Hewlett-Packard and shares increased by an exemplary 45%.
- The final, and most recent, economic period for analysis is from the third quarter of 2010 until the second quarter of 2013. During this period of time, Hewlett-Packard has experienced traumatic decline. What were once healthy returns have reversed into unmitigated losses at an increasing rate. This economic degradation is embodied well by the fact that HPQ went from earning around $1.5 billion per quarter at the beginning of 2012 to losing around $8 billion per quarter by the middle of the year. The company has increased in performance from the dark days of 2012, but the picture remains bleak. Investors seem to agree with this synopsis in that over this time period, shares have declined 53%
The chart above shows a simple, yet reliable relationship. As a firm betters itself fundamentally, investors tend to purchase shares. Conversely, as a firm experiences economic degradation, investors flee the security.
It is through the lenses of this relationship that we should examine Hewlett-Packard. History has shown that by making our investment decisions based upon fundamentals, we can not only profit, but potentially protect ourselves from abnormal loss. Hewlett-Packard, as seen in the chart of returns above, is currently in a state of economic decline. The firm is experiencing progressively worsening return on assets and profits remain at subdued levels. This type of soil is not fertile for the prudent investor seeking yield. It simply makes no sense to park capital with a company that is continuing to deliver worsening returns, especially when history has shown that this tends to lead to further price decline. And yet, price has rebounded 100% over the past seven months. In my opinion, this represents an excellent shorting opportunity. Since Hewlett-Packard was one of the most shorted listed securities, I view this rebound as a large "short squeeze" and recommend that the prudent individual who makes fundamental investment decisions seriously consider shorting HPQ.