So Long Moammar, Wall Street Rallies

Thanks to the good news coming out of Libya, the stock market looks to rally strongly this morning. Wall Street is focused on two events coming this Friday. The first is that the government will revise its report on second-quarter GDP growth. The initial report said that the economy expanded by just 1.3% for the second three months of the year. Wall Street expects that to be pared to 1.1%.

The other even is that Ben Bernanke will be giving a speech at the Fed’s annual shindig in Jackson Hole, Wyoming. This is where one year ago Bernanke announced the Fed’s plans for the second round of quantitative easing. Some analysts think this is the time he’ll unveil a third program to buy Treasury bonds (i.e., QE3).

Personally, I doubt that will happen although there could be a sort of extra buying announced. The reality is that the long-term bond market is vastly overstretched. Either the bond market thinks we’re going into a recession or they’re expect more Fed bond purchases. Still, I find myself looking at a third option which is that the bond market is just plain wrong on this. In deference to Jimmy McMillan, bond prices are too damn high and stock prices are too low.

One mistake that investors often make is that a lower price doesn’t necessarily mean that a stock is a good buy. It only means that the stock is cheaper than where it was. Earlier this year, shares of Hewlett-Packard ($HPQ) got chopped from $48 to $41 after the company announced poor earnings guidance. I got a lot of email asking me if HPQ was a good buy. According to the numbers, the answer was “yes,” but my answer was “no, HPQ is a sell.”

That’s a good example of when we have to see the numbers for what they are. They’re only a reflection of business reality, not business reality itself. When we take a closer look at what’s happening at HPQ, we can see that things haven’t been going well.

This is what I wrote six months ago in a post called, “Hewlett-Packard Is Cheap, For Good Reason.”

Since Hurd left HPQ, I’ve been down on the stock and fortunately I look smart today by telling investors to stay away six months ago. My concern is that the company’s aggressive acquisition plans may be doing more harm than good. HPQ has been going after IBM’s business in a big way and they’ve been shelling out major bucks to do it. I hated the 3Com purchase and the Palm acquisition still gives me nightmares. At the time, I gave Hurd the benefit of the doubt. Now that he’s gone, that benefit is also gone.

It boils down to the question: “Can new CEO Léo Apotheker engineer a turnaround from the previous turnaround?”

I say all of this in the context of last week’s earnings report. Hewlett-Packard reported earnings of $1.36 per share which was seven cents more than Wall Street’s forecast. Wall Street responded by tossing the shares in the garbage. The shares dropped nearly 10% on Wednesday. Since the stock is a Dow component, the plunge distorted the entire index.

What freaked out Wall Street so much? Let’s dig into the numbers. The hitch was that quarterly revenue rose only 4% to $32.30 billion from $32.96 billion. Wall Street had been expecting $32.96 billion. In the wider scope of things, that’s really not a big miss, so what else was going on?

Hewlett-Packard also gave guidance for Q2 and the entire year. For this quarter, HPQ said it expects revenues between $31.4 billion and $31.6 billion, and earnings-per-share between $1.19 and $1.21. Wall Street didn’t like that at all. The consensus was for revenues of $32.6 billion and earnings of $1.25 per share.

HPQ’s full-year forecast (their fiscal year ends in October) was for total revenues between $130 billion and $131.5 billion. The consensus on Wall Street was for $132.91 billion. HPQ said it expects full-year earnings to range between $5.20 and $5.28 per share. The Street was expecting $5.23 per share, so I suppose that’s inline. HPQ has traditionally issued conservative forecasts so they can raise them later. Perhaps they’re doing that now to mask the poor Q2 guidance.

So this seems odd. It appears that HPQ gave lousy near-term guidance but the long-term guidance is still what the Street expects. Yet the stock’s popularity is somewhere between Kim Jong-il and Diphtheria. (Did Hurd get out at the right time? Sure looks like it.)

According to the company’s guidance, the stock is selling for just eight times earnings. The good sign is that their enterprise storage, servers and networking division saw its revenues increase by 22%. Also, the gross margins are up 1.5% to 23.4%.

The stock is tempting, but I’m still steering clear.

HPQ has a few problems to work through. They’re experiencing weakness in consumer PCs and services. I’m also not a big fan of the quality of their earnings. Always be wary when a company grows too much through acquisition. That’s often a sign of trouble. A company should be focused on making earnings not buying them.

When I wrote that, the shares were at $43. Now they’re at $23.

Posted by on August 22nd, 2011 at 9:36 am


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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