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Elevator pitch / Executive Summary:

Recent Seeking Alpha articles regarding Hewlett-Packard (HPQ) have been mixed with respect to the future performance of share price, some indicating positive sentiment, whilst other authors who are "shorting" the stock are promoting a bearish overtone. This article assesses the recent share price performance and places this in context with the fundamental analysis to form a moderately bullish call for future share price performance up to two major resistance points that HPQ is most likely to test ($30 and $32.50, respectively).

Company description:

Hewlett-Packard Company is a technology and software solution provider with a broad range of consumer stakeholders ranging from individual consumers through to large enterprises and government institutions. Chances are that you've dealt with a HP desktop or laptop at some stage of your lifetime, which makes HPQ a highly recognized company worldwide. HPQ is one of the 30 Dow components, with a current market capitalization of $48.56 billion, and has received substantial media coverage in recent times due to the assignment of a new president and chief executive officer in Margaret "Meg" Whitman amidst a dramatic decline in the value of the company since 2010 (a 79.3% decline from the peak of $54.75 per share in April 2010 down to a multi-year low of $11.35 per share in November 2012).

Thesis & Catalyst:

The first half of 2013 has been a kind period of time for HPQ, seeing a 74% rise in the share price from $14.25 (closing price on 31st December 2012) to $24.80 (closing price on 28th June 2013). From a fundamental perspective, some of this price appreciation may be due to new hope inspired by a company turnaround plan released in October 2012, which is detailed further by fellow Seeking Alpha contributor Mark Meadows in his article 'Under Meg Whitman's Leadership, HP Stands To Gain 33 Percent'. From a technical perspective, this price appreciation confirmed an Elliott Wave 5 buy pattern on a weekly chart back in early-mid January 2013, as shown in Figure 1, with a successful re-test of the 30 week moving average that has increased ever since. Even though the Relative Strength Index (RSI) is approaching over-sold territory, the oscillator has formed a slightly higher peak with the recent high formed two weeks ago, which suggests that this upwards trend still has more room to move up to the Elliott Wave 5 buy target of $30 (which coincides with the next major point of resistance on the weekly chart).

Figure 1: Weekly chart for HPQ, highlighting confirmation of Elliott Wave 5 buy pattern, successful re-test of 30-week moving average and target of previous resistance level

(click to enlarge)

An examination of the fundamentals for the reporting years of 2009 through to 2012 provides an interesting insight which supports my thoughts that recent share price appreciation represents a "moderately bullish" call for the near-term future (rather than a strong bullish call). However, this "moderately bullish" call is still an opportunity to consider. HPQ's dividend per share (DPS) has increased at a reasonable pace over these reporting years - a 56.2% increase from $0.32 per share in 2009 to $0.50 per share in 2012 (see Figure 2), but this was not supported by a simultaneous rise in earnings per share (EPS). In fact, the EPS had decreased by 10.6% in 2011 (2010: $3.78; 2011: $3.38) whilst the DPS increased by 25% in the same year (2010: $0.32; 2011: $0.40). This tends to suggest that the company has used other sources of cash flow/finance to support the dividend payout increase; especially since the debt/assets ratio and debt/equity ratio have both increased over the four years examined (a 9.7% decrease in the number of common shares outstanding during the 2011 reporting year doesn't explain the discrepancy either). HPQ's research and development expenses have also increased over these reporting years (a 20.6% increase from 2009 to 2012).

Figure 2: Fundamental analysis of HPQ

(click to enlarge)

What is particularly concerning within the fundamental analysis is the incidence of negative figures reported in the 2012 financial year for both the EPS and the price/earnings (P/E) ratio. This indicates that HPQ experienced negative earnings over the reporting period - an aspect most unfavorable for a company!

At first glance, the 26.6% increase in sales per share from 2009 through to 2012 appears impressive, but when the 9.7% decrease in the number of common shares outstanding during the 2011 reporting year is taken into consideration, the effect is virtually negated (2010: $57.19 sales per share on 2,204 million shares; 2011: $63.93 sales per share on 1,991 million shares).

Overall, the fundamentals of HPQ appear unfavorable, especially in the light of negative earnings. Regardless, the market has been totally ignoring poor fundamentals for the company and is viewing HPQ in a positive light with respect to fundamental analysis, with the share price rising dramatically after the past two earnings releases at the end of February and May. This is evidenced by a rise of 12.3% on the day following the release of Q1 2012 earnings at the end of February, proceeded by a 17.1% increase in share price on the day following the release of Q2 2013 earnings at the end of May. As such, further rises in the share price to the targets presented within this article are quite feasible, especially when combining the positive market reaction and sentiment towards fundamentals presented in recent earnings releases with the positive trend in share price. The close alignment of the presented technical analysis with such market reaction towards fundamental analysis tend to suggest that the HPQ share price will continue to appreciate over the next month or so and head towards the predetermined targets noted later in this article.

A further reason for my thoughts of a "moderately bullish" call for future HPQ share-price performance relates to the overlying resistance points that exist on the weekly chart, which are difficult to ignore. Observing the current target of $30 (the first major resistance point for HPQ), the next strong resistance point hangs above, which is the 200 week moving average shown previously in Figure 1. As of today, the value of this 200 week moving average is $33.17, and is declining at a rate of $0.10 per week.

The opportunity that exists involves the purchase of HPQ shares or derivatives once the recent high of $25.87 (formed on 19th June 2013) is cleared, which is the immediate resistance point that exists for the share price. I also suspect that this is an area where current short-sellers of HPQ stock (such as fellow Seeking Alpha authors Investor Aide and QuandryFX) could potentially buy back their short positions in order to close-out their exposure, which would amplify the upward move.

As soon as a long position in HPQ is opened, the recommendation would be to set a "stop loss" below the recent low formed on 24th June 2013 ($23.19). An example of such position would be as follows:

  • Purchase 100 HPQ shares @ $25.88 and set "stop loss" at $23.18 (see Figure 3)
  • Potential risk of $2.70 per share if "stop loss" is triggered (i.e. $25.88 minus $23.18)
  • Potential reward of $4.12 per share if initial target of $30 is reached (i.e.: $30 minus $25.88)
  • Reward/risk ratio of 1.53 (i.e. $4.12 divided by $2.70).

This reward/risk ratio can be adjusted according to the reader's intention and risk appetite. A more aggressive investor may wish to enter the bullish trade at a lower price (prior to the suggested entry above the breach of the recent high), should they be more satisfied and confident with the trade set-up. In addition, an investor may not wish to be so lenient with the "stop loss", instead preferring to use a "stop loss" placed just beneath the rising 30 day moving average (see Figure 3). Both of these actions will increase the reward/risk ratio but this acts as a "double-edged sword" since it also increases the chances of being "whipsawed" out of the trade by sudden price movements.

Figure 3: Daily chart for HPQ highlighting reward/risk ratio for a moderately bullish trade once recent high is breached

(click to enlarge)

Whilst mentioning the potential for sudden price movements, it should not be forgotten that the next earnings release for HPQ is 21st August 2013. Unless you are entirely convinced that trading in HPQ shares will react positively to the earnings release (or unless you have purchased adequate put option protection well before the earnings release), this trade should be exited the day before earnings. As such, this trading opportunity is a short-term opportunity, which could potentially be reversed into a "short"/bearish possibility should the fundamentals of the company continue to remain meager and the market reacts poorly to the earnings release.

Also, please note that these calculations are based upon the initial price target of $30. Should the momentum of share price movement increase dramatically on its way to $30, the possibility exists that the next strong resistance point discussed previously (being the 200 week moving average shown previously in Figure 1) will then be tested. As stated previously, the current value of this 200 week moving average is $33.17, and is declining at a rate of $0.10 per week. Since the earnings release is not for another six weeks, a reasonable price target would be $32.50, which corresponds to a reward/risk ratio of 2.45 (using the same parameters listed earlier), as shown in Figure 4.

Figure 4: Weekly chart for HPQ highlighting reward/risk ratio for a moderately bullish trade once recent high is breached

(click to enlarge)

Variant view - What could go wrong with this thesis?

As stated previously, the absolute worst case scenario would be the triggering of the "stop loss" that is created as soon as you enter the trade. In that case, the total maximum risk would be $2.70 per share, plus brokerage fees for opening the position. For those who wish to be more conservative (but potentially "whipsawed" out of the trade), the "stop loss" could instead be placed just beneath the rising 30 day moving average, as shown previously in Figure 3. Alternatively, a protective put option could be purchased for each block of 100 HPQ shares owned in order to hedge the risk or mitigate against any volatile movement that could result in "gapping down" of the share price due to a catastrophic event.

Disclaimer: Please refer to my profile for full details regarding my disclaimer regarding articles written for Seeking Alpha .

Source: The Case For A Moderately Bullish Call On Hewlett-Packard