Should You Buy Hewlett-Packard After Earnings?

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Hewlett-Packard (NYSE:HPQ) on Thursday afternoon inadvertently released its earnings before the market closed. This sent shares sharply lower as analysts were disappointed in the company’s numbers. This is despite the fact that the company reported an earnings number that was relatively strong compared with last year: EPS came in a 66 cents per share versus 55 cents per share a year earlier.

Despite this improvement on an EPS basis, the company showed several troubling signs that indicate to me that the stock is not a good long-term investment. Here’s why.

First, while EPS rose by 20 percent, net earnings only grew by 18 percent, which reflects that the company’s stock buyback program is doing a good job reducing the number of shares outstanding. But investors should take a look at the company’s history of repurchasing shares — it’s not pretty.

The company repurchased a lot of stock in 2010 and in 2011 — $17.6 billion worth in all — as the stock began falling. At the time the company wasn’t prepared to deal with its pricing power issues. As management faced commodification of the PC industry, it reacted by repurchasing stock and making irrational acquisitions.

When the stock fell to the low double digits, the company stopped buying back stock in order to repair its balance sheet and its reputation. Now with the stock price back up, the company is repurchasing shares again. Although there is a different management team in place, one has to wonder whether this is a good idea, and investors should be concerned.

Second, while income rose, revenue declined by about 1 percent. This reflects the aforementioned trend of PC commodification, as well as weakness in consumer and business spending. This means that the company was able to grow profits because it cut costs elsewhere. We learned that management plans to cut jobs, which should cut SG&A expenses going forward. Also, if you look at the earnings numbers, most of the income differential between last quarter and the second quarter from 2013 was the result of a decline in “unusual expenses.” In fact, if we normalize for both this number and “depreciation and amortization,” Hewlett-Packard’s net income actually fell year over year from the same quarter last year.

I should also note that the “unusual expense” category is an accounting category that is often reserved for onetime expenses, and the idea is that the company and analysts are supposed to value the stock as if these expenses were zero. Of course this is ridiculous, but it is something of special interest for companies that report these “unusual expenses” quarter after quarter. Hewlett-Packard is one of those companies. The number has exceeded $1 billion per year in each of the last four years. The one time when there seems to be a real unusual expense is in fiscal 2012, when the company wrote down its failed acquisitions and the number exceeded $20 billion.

Given these points Hewlett-Packard’s numbers aren’t so great, and I suspect that this is responsible for the stock’s decline on Thursday.

More generally and from a longer-term perspective, Hewlett-Packard faces numerous problems. The most obvious is the fact that there is ever-increasing competition in the PC market, and these products are becoming less expensive and less profitable to produce. The same can be said about other pieces of hardware that Hewlett-Packard produces such as printers, scanners, and tablets. The company can increase its profits and margins using tactics such as stock buybacks, layoffs, and other cost-cutting measures, but these don’t fix the company’s underlying business from a long-term perspective. They only make earnings look stronger in the near term.

Unless the company can improve its brand image or come out with a new product, the shares seem dangerous to me. This is despite the fact that they trade with a low double-digit earnings multiple. You are better off paying up for the earnings of a company that doesn’t face the headwinds that threaten Hewlett-Packard.

Disclosure:Ben Kramer-Miller has no position in Hewlett-Packard.

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