Shares of personal computer and printer company HP (HPQ 1.55%) have more than doubled over the course of the past 12 months, recently reaching a two-decade high. Not bad.
The rally reflects a modest rebound of the personal computer market before COVID-19 took hold, followed by an acceleration of that recovery spurred by the pandemic itself. For the three-month stretch ending in March, technology market research outfit IDC says shipments of PCs grew 55% year-over-year. Gartner pegs the figure closer to 32%, using a slightly different criteria for what constitutes a personal computer. IDC and another market research company called Canalys agree that personal computer sales will see net average growth through 2025. It all certainly seems to bode well for HP's business.
Three things are largely being obscured by all the bullish rhetoric, however, that are apt to work against HP shares sooner rather than later. If you were planning on getting out in the foreseeable future, maybe now's the time. And if you were thinking about getting in, you may want to hold off.
Image source: Getty Images.
1. We're at peak PC
HP, formerly known as Hewlett-Packard, is certainly well positioned to report strong quarterly numbers next month. The analyst community is modeling nearly 16% sales growth -- in line with IDC's and Gartner's calculations -- driving a 72% improvement in profits.
But, the current environment is going to be a tough act to follow.
IDC's expectation for a compound annual PC sales growth rate of 2.5% between 2020 and 2025 includes 2020 and 2021. Those two huge growth years are skewing the CAGR, meaning the last three years of that five-year stretch are going to be below average; they may even be negative. Ditto for Canalys' compound growth expectation of 3.5% for 2021 to 2025. Canalys' call for 8.4% growth between 2020 and 2021 means the very best growth is happening right now, or has already happened.
The risk is simply that current shareholders are underestimating how different the near future will look from the recent past. About two-thirds of this company's business typically comes from the PC market, versus a third stemming from printer sales, so the PC market is very important to the company.
2. Analysts maintain it's overpriced
Investors should not have blind faith in every analyst estimate. It's noteworthy, however, that the analyst community didn't budge its average target price of just under $31 when the stock blasted well past that point five weeks ago.
The analyst community's price target changes have historically been responsive to the stock's price changes, as these people work to use current information to make inferences about its future value. Only on rare occasion has the price of HPQ eclipsed the consensus target, and when it has, it didn't for long, and not by much. This is the longest and largest divergence we've seen above the average price target in the past two years. It's generally not the sort of extreme that investors want to see tested.
Data source: Thomson Reuters. Chart by author.
This hesitance to raise their consensus target certainly isn't due to a lack of information either. In HP's Q1 report posted in February the company offered clear second-quarter earnings guidance, and IDC's long-term computer market outlook was published in January. Gartner dished out its Q1 count pretty early this month, and Canalys posted its Q1 expectations and outlook last month. Nothing's significantly changed in the meantime. These pros seem to be making a calculated, conscious decision to stick with their price targets below the stock's present price near $34.40.
3. An unusually high valuation
Finally, HP shares are now at valuation levels this stock hasn't seen since 2018. That's when notebook sales and prices were firming up and investors were celebrating a couple of small acquisitions. Neither tailwind would last, quickly deflating the stock's premium valuation.
The chart below puts things in perspective. The present trailing 12-month price-to-earnings (or P/E) ratio stands at 14.2, while the forward-looking, estimates-based multiple is 10.5. That's cheap by technology stock standards, but not by HP's historic standards. This is a name that typically trades in the single digits on a backward-looking basis, and around 7 in terms of projected profits.
Data source: Thomson Reuters. Chart by author. Final EPS bar is forecast figure for period ending this month.
Don't misunderstand. In most cases paying up for a quality name is worth it in the long run...particularly if solid and significant growth is in the cards. it's not clear HP's got any real growth on the horizon though, only bolstering the risk of a valuation that's already on the order of 20% above its 2019 and 2020 norms.
Bottom line
To be clear, my concern is more about the stock and less about the company. HP may never be a high-growth company again, but to a certain set of investors, it's a rare dividend play from the technology sector. Even at its currently lofty price, HP's dividend yield is a healthy 2.3%, and even 2019's pressured pre-COVID operating profits of $2.24 per share easily covered the annualized dividend payout of around $0.70. There's always a slim chance the company just might find or even develop a new market niche that drives unexpectedly strong growth.
From a risk-vs-reward perspective though, newcomers are paying something of a premium for a company that doesn't quite deserve one of this magnitude. Stay on the sidelines for now, and if you already own it but were looking to get out, this could be a nice exit opportunity.
