Is It Time To Buy Hewlett-Packard?

| About: HP Inc. (HPQ)

So, you missed the rally that began since March 2009?

Hewlett-Packard Company (HPQ), as of yesterday, closed at $24.31, a level last seen during March 2009, when markets were trading almost at the lowest level of the past decade. Will you buy it now?

In this post, I am going to share my value as well as technical investment take on this company. Finally, I shall also share some ideas on how options can be used to hedge and/or to lower your cost.

Value Take:

Based on my analysis using discount cash flow models, I think Hewlett Packard is undervalued. The selling pressure is driven by recent lackluster performance and uncertainty around the company's future. It is going through tough times and there is no clear direction emerging, which is further depressing stock value.

Let's dive into numbers. (Learn how to Value Stocks and for an example of a company that was later purchased.)

  • Assuming 0% growth going forward, using last 10-year normalized average earnings of $2.07 (last 3 years is $3.38) my value target price comes to roughly $17.60, and assuming just 1.5% growth my derived intrinsic value is $23.80 vs. current share price of 24.30 which is just 0.4x sales and 1.2x book value. (Assumption 2.128 billion shares outstanding).
  • If I take FY 2010-11, 8.1 billion owner's earnings* (approximated by free cash flow), use 0% growth and discounted using 10% Weighted Average Cost of Capital (WACC), the intrinsic value is roughly $30. If there is any growth above 0, say same as expected US GDP of ~ 2% and discounted it using 10% WACC, the price can easily move to almost $37.

*What is Owner's earnings? It is Net Income + Depreciation + Amortization + One-time Savings - One time expenditures - Capital Expenditures.

  • However, If you factor analysts' estimates of long term growth as ~4% and discount it using 10% WACC, share price intrinsic values jumps to $45+
  • You could dress up the numbers as you like, but even after assuming 2 to 3% decline for the next 2-3 years followed by return of growth to roughly 2%, it will still give you a value higher than current prices.

Watch-out: It is not yet a bargain in traditional margin of safety context and Hewlett-Packard may just not sustain its competitive advantage going forward. It may also not be able to reinvent itself. It may see business decline continuously. Those are clearly risk factors associated with the purchase of stock. Value investing is done when almost all others are fearful. To overcome that fear, the key is to value correctly.

Above analysis is by no means the most accurate analysis of HP's value, but at least it points you towards an idea that's screaming for attention.

Technical Take-

Here is a 20 Year chart of the company. Currently it is trading below financial crisis levels and is quite close to a major support line.

Click to enlarge.

HPQ Price Chart for the past 20 yearsClick to enlarge

Source: Prophet charts.

Though there is a possibility that the price may undercut this trendline still, I personally would be a buyer around $20-$24 zone. I usually don't buy at a single price, and almost always scale into a position.

How could you use options to either hedge and/or lower your cost.

There are couple of ways to play this-

  1. One can buy shares and buy ATM puts to hedge it.
  2. One can by shares, buy ATM puts and sell OOM calls to finance purchase of puts to create bracket and limit the gains. Keep repeating it if HP either continues to rise or fall or till it hits your stop loss.
  3. One can sell naked puts, if assigned buy shares, sell puts again and write calls to make money from either side movement.
  4. One can buy simple straight ITM (or OOM) leap calls
  5. The options' possibilities are enormous, there are still many more ways to play bullish bias with defined risk and higher leverage (e.g. credit spreads, calendars, etc.)!!!

Bottom line: I will be a buyer as per the scenarios mentioned above.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in HPQ over the next 72 hours.

Disclaimer: Please do your due diligence before investing any money based upon this article. This article is presented for information purpose only.