Time To Move Hewlett-Packard Profits To Apple

Jun.27.14 | About: Apple Inc. (AAPL)

Summary

Gross margins often forecast a company’s growth picture.

Innovation will continue to allow Apple to participate in a growing market while Hewlett-Packard needs to invest heavily in research and development to transition out of a shrinking market.

Stock valuations relative to growth outlooks paint very different pictures for each company.

While I don't believe that owning Hewlett-Packard (NYSE:HPQ) is a bad investment, investors seeking to maximize growth within their technology allocation might consider selling Hewlett-Packard shares and using the proceeds to invest in Apple (NASDAQ:AAPL).

Gross Margins Equal Growth Outlook

One often overlooked metric used to evaluate growth potential within stocks is gross margin analysis. Theoretically shareholders should benefit more as a corporation's bottom line grows. In Hewlett-Packard's case, profitability within the PC and printer markets is experiencing a slow death. While HP has done an admirable job of transitioning business models since Meg came on board, the stock price fully reflects the share price benefits related to this transition going forward. For example, Hewlett-Packard's stock price has enjoyed an increase of more than 35% in the past year while gross profit margins still remain disappointing at 27.2% and net profit margin is 4.66% which is significantly lower than the industry average. On the other hand, Apple has gross margins close to 38% and net margins around 21%. This comes even with a decline from increased competition in the smartphone market. In addition, Apple's introduction of the iWatch and iPhone 6 should only improve those numbers. Investors should be aware that historic analysis of trends within gross margins often directly correlates to the price-performance of the stock.

Innovation Comparison

In addition to gross margins, new products and services driven by innovation also contribute to the price-performance of a company stock. While Hewlett-Packard has been busy shifting its business strategy internally, it has sacrificed innovation (at least for the short term). In fact, the difference between HP and competitors regarding R&D investment and acquisitions has become increasingly wide. In the short to intermediate term HP will continue to pursue server technologies as its foundation for innovation. This could prove very profitable down the line. However, many unknown risks associated with this change still remain to warrant the stock price at these levels. Apple, on the other hand, will soon present several new products and services that will not only keep the growth engine running strong but could also provide the next catalyst to send shares significantly higher. It's no secret the iPhone 6 will have numerous upgrades with its release this fall and should position Apple well in a smartphone market that is still expected to have double-digit growth in the next year. Each new iOS device including phones, tablets and perhaps the iWatch should strengthen and increase Apple's ecosystem as customer loyalty remains strong.

Valuation Going Forward

Given the fact that Hewlett-Packard's revenues are expected to decline over the next several years as the company continues its strategy transition, price-to-earnings ratios will begin to inflate. In addition, HP's shift to the cloud arena from processing and storage data could also compress already thin margins. These conditions should keep Hewlett-Packard's share price in a tight or even lower trading range. In contrast, Apple's five-year growth forecast is estimated to be around 10%. The average growth estimate for earnings is around 14%. Should Apple come in with annual earnings of around seven dollars per share and a 15 multiple, Apple's target price would be around $105 per share. That would represent a 17% gain from current levels.

Given the internal financial metrics and current share values, investors wishing to maintain a blue-chip technology company might consider substituting their Hewlett-Packard position for Apple shares.

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