Wildly Undervalued Stock Could Deliver Big Profits by Year End
You might think we are crazy for going long a stock that has posted revenue declines in 15 of the past 16 quarters — a stock that has also underperformed the S&P 500 by 24 percentage points over the past 52 weeks.
But we are. And we have good reason.
Both fundamentally and technically, Hewlett-Packard (NYSE: HPQ) appears to be on the verge of an important turnaround that should send shares significantly higher.
For starters, HPQ is selling at a bargain-basement valuation compared to other tech stocks.
Its current P/E is 11.1 while the S&P 500 Information Technology Index trades at 18.8 times earnings. And HPQ’s forward P/E of 7.3 is less than half that of its sector index.
If you argue that many fast-growing tech stocks like Apple (NASDAQ: AAPL) and Google (NASDAQ: GOOGL) skew the broader valuation, it should be pointed out that in the top 10 index weightings are several mature stalwarts like IBM (NYSE: IBM), Cisco Systems (NASDAQ: CSCO) and Intel (NASDAQ: INTC).
Plus, the valuation doesn’t just come through when looking at earnings. HPQ is currently trading for a price-to-sales (P/S) ratio of 0.48 versus a ratio of 3.1 for the Information Technology Index. On a price-to-book (P/B) basis, HPQ sells at a multiple of 1.87, less than half the index’s 4.08.
As recently as 2010, HPQ traded at more than $50 a share. What has made investors sour on the stock is that two of its legacy businesses — personal computers and printers — still account for about half of all revenue and have been in a long-term sales decline. Results from the third quarter, which HPQ reported in August, showed the company’s personal systems revenue fell more than 13% year over year and printing was down 8%.
Meanwhile, total revenue dropped 8% to $25.3 billion in the most recent quarter from the year-ago quarter. Over the same period, third-quarter earnings per share (EPS), although in line with expectations, fell by a penny to $0.88.
The quarter, however, was still seen as a victory by many analysts. Toni Sacconaghi of Bernstein Research commented results were “better than investors had feared.” He maintained an “outperform” rating on the stock. Katy Huberty of Morgan Stanley (NYSE: MS) remained “overweight” the shares and said the enterprise division of the company “appears to be turning the corner.”
Interestingly, of the 21 analysts who follow the stock, the lowest target is currently $30 per share — which is 11% above current prices. The average target is near $38, while the high target is $45, which is 67% above current prices.
An important catalyst for unlocking shareholder value will be the company’s upcoming restructuring into two publically traded entities — Hewlett-Packard Enterprise and HP Inc — which is scheduled to occur this November.
HP Inc will house the old-line PC and printer divisions, with 3D printing expected to be a growth area. It will be headed by Dion Weisler, current executive vice president of these divisions.
Hewlett-Packard Enterprise will house the high-potential areas of servers, software and cloud technology, and will be led by current HPQ CEO Meg Whitman. When the restructuring plan was first announced, she commented that the split will “provide each new company with the independence, focus, financial resources and flexibility… to adapt quickly to market and customer dynamics.”
Whitman promised to provide further details on the split at the company’s upcoming analyst meeting, scheduled for Sept. 15. Traders should circle that day on their calendars because the buzz both before and after the conference could cause the stock to pop.
HPQ appears to be nearing an important technical turnaround, as well.
As the three-year chart shows, shares bottomed in the mid-$10 range in 2012. They rebounded sharply from there, more than doubling to above $26 in about a year. The trendline off that low was very steep, indicating the rally was unsustainable.
HPQ then retreated quickly, making a secondary low around $20 in October 2013, and then held to the low’s new major trendline for more than a year. During this time, shares more than doubled, with HPQ peaking at over $40 at the beginning of 2015.
Next, the stock went down in almost a straight line, hitting what seems like a sustainable bottom just under $25 on Aug. 24 — what many analysts are now calling “Black Monday.” Shares have rallied sharply since.
A downtrend line drawn from the January high currently intersects the chart just below $30. If the shares break that nine-month downtrend line, it will be an important technical buy signal.
Given the current market volatility, we will play this trade safe and set a buy-stop order at $30.11, right above where the downtrend line would break. A stop-loss should be set a tad below the Aug. 24 panic low at $24.79. In terms of a target, shares could retest the previous high above $40, so we’ll set a target of $39.95.
Recommended Trade Setup:
— Set buy-stop order for HPQ at $30.11
— Set stop-loss at $24.79
— Set price target at $39.95 for a potential 33% gain by year end
You could actually turn this move into a 267% profit risking just $435 if you follow a strategy known as the Levy Technique. Learn more here.