When a Nobel Prize-winning economist (Robert Shiller) says he's "worried about the boom in the U.S. stock market" (in this December 2013 Reuters story), then speculation about a market bubble has reached the mainstream. The next step usually comes when most media commentators throw in the towel and admit to some new paradigm or other reason that the market is going to move higher. The IT sector is experiencing particularly heady valuations, so is there a value play left? We look at Hewlett Packard.
Nowhere is the euphoria more evident than in IT, where commentators are experiencing disconcerting tech-bubble déjà vu. However, some companies haven't arrived at the valuation party. One such large cap is Hewlett Packard (HPQ.N) which has yet to recover fully from the disastrous acquisition of Autonomy Corp. and the resulting $8.8 billion writedown. In many ways HPQ looks similar to Dell - it's only a shadow of its former glories.
Maybe not a value trap
The naysayers will scream that HPQ could be a black hole masquerading as a value proposition. And yet … StarMine's Analyst Revisions Model score is an impressive 84 (data from Jan. 3). This indicates that sellside sentiment is changing in a more positive direction, with longer term revenue and EPS estimates starting to drift higher (FY2 EPS estimates are up 4.6% over 90 days). It's a positive sign that EPS and revenue are moving in the same direction. According to StarMine, EPS revisions that are driven by revenue growth are normally more powerful than EPS growth that is not matched at the revenue or EBITDA line (i.e. probably driven by cost cutting).
Price momentum also looks reasonable - the stock has a Price Mo score of 70 and has strong medium and long term momentum, as well as short term industry momentum (U.S. computers & peripherals are up by 5.3% over 30 days). So if this is a value trap, it's well-hidden. It appears to be more a stock starting to turn the corner with the market and sellside analysts starting to get on board.
What about valuation? Well, HPQ trades at 7.7 times 2014 earnings - its 10 year median valuation is 11.3 times and its peers are trading at an average of 11.6. Looking at its valuation from another angle - the current price around $28.00 implies negative growth of 0.3% over the next decade. That certainly leaves some room for outperformance. StarMine's SmartGrowth forecasts, which take sellside short and long term earnings forecasts and attempt to remove over-optimism bias - still project a 10 year CAGR of 4.6%. Hardly bullish, and about half the industry average of 8.8%, but still enough to calculate a valuation of over $44.
Earnings quality - check, cash flow - check
Earnings Quality also looks robust, with operating efficiency continuing to move in the right direction and gaining a percentile score of 94. Free cash flow generation is also attractive, scoring in the 90th percentile for U.S. stocks.
The hedge funds have also closed their shorts. The Short Interest model moved down to a score of 30 during the dramatic share price fall in 2012 but the shorts have drifted away - no doubt more attracted to the euphoric valuations of social media and cloud based analytics.
Lastly, the sellside have not yet bought into the story - while recommendations are drifting higher, the average is still only slightly better than a hold. There are 23 holds and three sells - that leaves plenty of room for the unbelievers to convert and institutional interest to start to return.
HPQ has its challenges, no doubt, but with estimates drifting higher, an inexpensive valuation, and high levels of both buyside and sellside skepticism, it seems that HPQ doesn't need to do much to give the market a positive surprise. The tablet has certainly had a transformative effect on the industry - but the desktop PC, laptop and printer are not dead. Perhaps rumours of Hewlett Packard's demise are also exaggerated.