Mobile computing devices, such as smartphones and tablets, are displacing laptop and desktop computer sales in developed economies. This structural shift in the technology sector has sent shares of many personal computer companies down in price. Are their valuations low enough at today's market prices to justify the risk of investing in a losing sector?
The End of An Era
After being number one in market share for six straight years, Hewlett-Packard Co. (HPQ) has dropped to second place behind Lenovo Group (LNVGY.PK). Surely this change was no surprise for HP CEO Meg Whitman, since it was widely anticipated by analysts and did not happen overnight.
Market research firm Gartner cited Lenovo's acquisition of IBM's (IBM) personal computer unit seven years ago as a crucial source of its success. Lenovo captured 15.7% of sales in the last quarter, as compared to Hewlett-Packard's 15.5%, according to a Gartner's report.
Hewlett Packard's sales slump is widely attributed to the decline in the demand of PC units after the sudden emergence of smartphones and other mobile devices like the iPad. Reigning since 2006, Hewlett-Packard has been unable to compete against Lenovo in developing markets.
Lenovo gained mostly in the less-developed countries - its planned acquisitions and high penetration in the emerging markets are outpacing the developed ones. Pacific Crest Securities analyst Brent Bracelin said, "It's a whole new bigger trend coming, not just Lenovo."
Don't Pay Premiums in Troubled Sectors
Many firms in the personal computer ecosystem are seriously threatened by the evolution of consumer computing. Stock investors must demand a discount in the form of low valuations before even considering investing in these firms.
First off, let's consider recently dethrowned Hewlett-Packard. After a -42.7% drop in 2012, its $14.50 share price provides speculators a betting opportunity. When compared to the 1.32 price-to-sales ratio of the S&P 500, the 0.23 ratio of this stock is very attractive. The 0.9 price-to-book multiple of this stock is also very attractive, much cheaper than the 2.07 S&P 500 average.
Investors should consider Hewlett-Packard's valuation very cheap because the price-to-book ratio fails to account for internally-developed intellectual property, including patents, brands, and trademarks. If the economic value of these assets were even partially recorded on the balance sheet, the firm's price-to-book ratio would be lower.
Hewlett-Packard has attracted attention from analysts as a possible break-up play. UBS (UBS) analysts concluded that Hewlett-Packard ought to separate its business solutions division from its personal computers and printer operations. HP shares would be worth $20 or more per share if the businesses were run separately. This is much higher than the $14.50 price of shares today.
The analysts led by Steven Milunovich stated, "HP, with its fully developed enterprise and consumer businesses, should split up in order to realize greater value." Milunovich believes that any loss in purchasing power would be more than made up for by an increase in management focus and that at the current share prices, HP investors are actually getting the printer and PC business for free.
That's great on paper, but without a management decision, a spinoff or business sale will not happen. There is no way to unlock value without a key. Hewlett-Packard refuted the concept that it would break up. According to spokesman Michael Thacker, Hewlett-Packard is stronger together than apart and the customers believe in one HP. CEO Meg Whitman said that she would not spin off the personal computer business, though this course of action was considered by her predecessor Leo Apotheker.
Since investors should not hold their breath for any fix from HP's management, they should expect this company to continue suffering net losses. These losses could also force the company to slash its 3.65% dividend as well.
Another beaten up stock is Dell (DELL). It's a better speculative play at roughly $10 per share. It trades at a 3.35% dividend yield, a 0.27 price-to-sales ratio, and a bargain 5.65 price-to-earnings ratio. In terms of these valuations, it trades at roughly half the valuations of the S&P 500 index. It's a bit safer of a bet than HP because it's operations are still profitable.
Income investors can find dividend yields at reasonable prices by buying shares of Intel (INTC) at $21 per share. This semiconductor large cap stock is much less speculative than Dell. It pays a hefty 4.23% dividend, which is more than twice the 10-year treasury yield. Future dividend payments are likely because the company pays out 0.34 of earnings as dividends, so earnings could drop considerably before dividends must be cut.
Intel's 1.95 price-to-sales ratio is in line with today's prevailing market multiples. Intel's shares are valued at a compelling 9.01 price-to-earnings ratio, a value which is significantly lower than the 14.23 average of the S&P 500.
At $29 per share Microsoft Corporation (MSFT) is not as compelling. Sure, its shares pay a dividend yield of 3.21% based on a sustainable 0.40 payout ratio. However, investors can buy more revenues per dollar from the S&P 500, since this index has a price-to-sales ratio of 1.32, while this stock has a much higher 3.28 ratio. Microsoft shares are trading at a fair 14.32 price-to-earnings ratio, in line with the S&P 500 average. These price multiples are not sufficiently cheap given the macroeconomic challenges facing Microsoft.
For comparison we can look at Apple (AAPL). At $610 per share, its valuations are very similar to Microsoft's valuations. Its price-to-sales ratio is 3.84 and its price-to-earnings ratio is 14.34. Clearly, at similar valuations, investors should buy Apple's actual growth story over Microsoft's hypothetical one.
The creative destruction in the consumer computing markets does not seem to be rationally priced into different stocks. Intel appears to be a better value play than Dell or Hewlett-Packard. Apple is clearly a better growth play than Microsoft.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.