Time to Buy Hewlett-Packard?

Now that shares of Hewlett-Packard (HPQ) are getting knocked down due to the resignation of CEO Mark Hurd, is the stock worth buying?
Just looking at the numbers, HPQ is a bargain stock. The earnings line was only barely impacted by the recession, and the shares are going for less than 10 times the estimate for this fiscal year’s earnings.
The problem, however, is that the stock has low-quality earnings. Herb Greenberg shines the spotlight:

Consider that much of the growth under Hurd was through acquisitions, culminating with its 2008 acquisition of EDS and more recently such controversial deals as 3Com and Palm. Including those three deals, HP did more than 30 acquisitions under Hurd at a cost of more than $25 billion, or roughly half the company’s current market value (earlier post misstated the figure as $50 billion). That’s roughly double the prior five years, according to a listing of deals on HP’s Web site.
But while the more than $25 billion may have helped push the stock higher, consider that:
* The companies HP acquired since 2005 generated revenue of around $25 billion (based on a rough calculation using publicly available data on the biggest deals since the end of fiscal 2004 – or around five months before Hurd arrived.)
* Total revenue increase during the same span was around $34.5 billion or an impressive 44 percent or around an average of 9 percent a year. Put another way, without the acquisitions revenue would be up just 9.5 billion or just 11 percent — or barely an annual average of 2 percent a year.
Meanwhile, earnings per share during the Hurd era posted compounded average annual growth of 22.5 percent a year. But a chunk of that is related to:
* Merger-related cost-cutting.
* A decline in shares outstanding, thanks largely to buybacks.
* An 18 percent drop in research and development spending, not necessarily an admirable trend for a tech company.
But, wait, there’s more:
* Sales at four of five operating units, including PCs and printers, have tumbled an average of 15 percent from pre-recessionary 2008 peaks. (The noticeable exception is the services business, whose revenue roughly doubled after the EDS acquisitions.)
* Profits at those same operating units fell an average of 18 percent during the same period.
* Finally – and this gets to the heart of our earnings quality question, which I focused on in a column here in June — HP has conditioned Wall Street to view it on a non-GAAP (or other than Generally Accepted Accounting Principles) basis, and investors have gullibly gone along with the game.

It looks like the market wasn’t much fooled. Here’s a look at HPQ’s share price (blue line, left scale) along with its earnings-per-share (yellow line, right scale) plus the the projected EPS (red line).

The lines are scaled at a ratio of 10 to 1 which means whenever the lines cross, the P/E is exactly 10. The next earnings report is due in just 10 days. For now, I’d stay away from Hewlett-Packard.

Posted by Eddy Elfenbein on August 9th, 2010 at 2:15 pm

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