This week’s overvalued company of the week is Hewlett-Packard Company (HPQ). HP is a manufacturer and provider of computer solutions for individuals and companies. We will analyze this company using Warren Buffett’s approach for the Business and Management Review, and use Benjamin Graham’s methods for equity valuation.
Business and Management Review
1) Is the business simple and understandable
Hewlett-Packard is a computer manufacturer producing personal and corporate computing solutions, as well auxiliary items for consumer use. Hewlett-Packard in its current state is the result of the acquisition of then rival, Compaq Computers. The business is fairly simple to understand, however, it does become somewhat blurry as to the reasons and rationale for Hewlett-Packard to be engaged in certain product lines. The acquisition of Compaq was as well confusing and hard to understand the reasoning for acquiring a computer maker that had dwindling market share.
2) Does the business have a consistent operating history?
The operating history of HP has been unstable. EPS has been very volatile in the past few years averaging down -14.55% over the past five years. Net income has also been a wild card for the company, as it has seen negative net income in 2002 followed by positive gains in 2003 and 2004, but net income again dropped in 2005, down 30% year over year. Overall, net income has averaged a decline of -8.45% over the past five years.
3) Does the business have favorable long term prospects?
Hewlett-Packard is in deep competition with Dell computers, and in the foreseeable future Dell will continue to run ahead of HP. The small, but increased market share of Apple Computers has also diluted the marketplace further. Hewlett-Packard has an image problem, especially with its Compaq division, long known for lacking in quality in comparison to other competitors. We feel that Hewlett-Packard will continue to struggle against other competitors and its market share will not increase enough to make a run towards greater profitability for shareholders. HP does have a wonderful reputation in its printer division, even with companies such as Dell trying to compete in that market.
4) Is management rationale?
Taking the obvious current crisis in Hewlett-Packard aside (corporate spying scandal ) Hewlett-Packard still has some management problems to address. Firstly, and most importantly the acquisition of Compaq for $20 billion+ made little sense to investors and a long and costly fight within Hewlett-Packard eventually failed and the acquisition proceeded. It was obvious that HP earnings would suffer initially due to the cost of acquiring Compaq, but here we are five years later still waiting for the implied profits to begin commencing. Of course, the management that was in place for the merger is no longer around, but there is still a culture which is evident from the spying scandal that Hewlett-Packard needs to clean house and bring in fresh new management that will uphold the shareholder’s interests.
5) Is management candid with its shareholders?
As typical with most companies with a dominant web presence it is easy for them to communicate with their shareholders. Hewlett-Packard does the same (investor relations) providing the typical information one would expect from a company the size of HP. From current stock prices, to annual reports and audio and video files of conference calls, HP provides in depth information for the investor.
6) Does management resist the institutional imperative?
Hewlett-Packard does a poor job of avoiding such actions which is evident from the acquisition of Compaq and a general lack of attention paid to shareholders.
Financial and Value Review
Hewlett Packard does not meet the criteria for either the defensive or enterprising investor. The company’s size, current ratio, lack of positive net income for the past 10 years, and high P/E and P/B ratios eliminate it from being attractive for a defensive investor. With a (see Our Methods) P/E ratio of 52.53 and ROIC of only 6.66%, Hewlett Packard does not pass any of our tests to identify a valuable stock selection. We find that the current share price is between 250-270% above the intrinsic value.
We would not feel comfortable owning Hewlett-Packard for more than $14/share. This given price is on a purely valuation process and still may not be a suitable price if the above mentioned issues are not resolved or in the process of doing so.
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