In a weird twist of fate, Hewlett-Packard (HPQ), Dell (DELL), Microsoft (MSFT) are all substantially undervalued and, in my view, likely to double in price. Once viewed as the darlings of their respective competitive circles, these top tech producers have lost their luster to next-generation competitors like Apple (AAPL). Still, so-called "maturity" offers exciting prospects for financing new growth and diversification. HP, Dell, and Microsoft all have solid moats, and are well positioned to capitalize on growing data trends, demand for innovation, and the rise of cloud computing.
The bears commonly deride HP and Dell as classic "value traps" that delude investors into confusing poor fundamentals with value. It is true that some companies may trade at low multiples because of limited growth prospects going forward or a poor underlying business, but HP and Dell face neither in the long-term or, for that matter, in the short-term under analyst expectations. Consider the following:
HP's current PE multiple is only 57 percent of the historical average. The shell of a giant is still there, and it comes with $9.3 billion in operating cash flow -- or roughly one-fourth of its market cap -- each year to invest in R&D for a revival. Perhaps most impressively, the company trades at less than 5x free cash flow. Moreover, performance has been excellent of late -- the last four out of five quarters beat expectations, and the other was in line.
Growth expectations for the diversified computer producer are also unreasonably low, which sets the bar low for outperformance. Analysts expect the company to grow 417 bps slower than expectations each year over the next five. No matter -- the company is still exceptionally cheap by these standards. Based on the consensus estimate of $4.06 for EPS in 2012, 2016 EPS will be around $4.88. A 12x multiple would put the future stock value at $58.56. An aggressive 12 percent discount rate would imply a $33.22 price target, which is at a 70 percent premium to the current value. The market seems to be factoring in a discount rate of 21 percent at already exceptionally low growth expectations. Moreover, I am just looking for the company to return to where it was roughly four months ago.
Dell is undervalued for much the same reasons under similarly bearish expectations. Here's a company that, while failing to excite the market, is worth only 5.2x free cash flow and has a current PE multiple that is one third of its historical 5-year average high.
Like HP, performance has also been better than expected. The last three quarters ending November 2011 were an average of 17.67 percent above consensus. Analysts are only expecting 4.5 percent annual earnings growth over the next five years, which is less than half of what is has been over the past five. This means 2016 EPS of approximately $2.42, which at a 12x multiple, translates to a future stock value of $29.04. The margin of safety is ~45 percent at a 10 percent discount rate and ~15 percent at 15 percent discount rate. Put differently, aggressive risk discounting on top of bearish growth assumptions already offer a 15 percent margin of safety that the stock will more than double in value!
Microsoft is more of a trusted investment right now and does not deserve to be valued at less than Apple. From the promise of Windows 8 to a virtual monopoly in PC and word processing, Microsoft has plenty of opportunities to expand. Demand for its products continues to increase in high-growth emerging markets while the brand resonates in future opportunities. The main problem with Microsoft is that attempts at entering new segments have been disappointing.
But that doesn't mean that Microsoft won't succeed in expanding its moat. The leading software producer has still established footholds in various industries from mobile to search and social media. It is less a matter of execution and more a matter of time before the company finds a strategy that "clicks" with the unpredictable tech market. Consumers will come and go in technology, so diversification is key in Microsoft's pursuit of unlocking value.
Fortunately, Microsoft has plenty of value to unlock. Consistent operating performance points to 2016 EPS of around $4.50. This indicates a future stock value of $67.32 at a 15x multiple. Discounting backwards by 10 percent implies a $41.80 price target. It would take a roughly 17 percent discount rate to justify the iconic company's current valuation. Investors are thus advised to aggressively accumulate shares.
Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.