3 Reasons to Buy HP, 3 Reasons to Sell

The past year has been pretty cruel to Hewlett-Packard (NYSE: HPQ  ) investors. First, the company suffered through a scandal that not only saw top executive Mark Hurd leave the company, but then saw him bolt to Oracle (Nasdaq: ORCL  ) , a company increasingly in direct competition with HP. In the following months, HP fell after issuing earnings with uninspiring forward guidance that hinted at weakness in the second half of fiscal 2011.

However, after all the body blows to its stock, HP is trading for a miniscule P/E of 10.5. Is HP a bargain-basement deal at this price, or have investors been wise to abandon the stock. We'll take a look at not only the key opportunities investors should be watching at HP, but also the key threats that could send the company's stock collapsing.

What to watch for: The good

  • While servers can be a somewhat commoditized business, HP has done a good job expanding its market share, especially in more high-end portions of the market. In IDC's fourth-quarter server market share report, HP managed to capture 52% of revenues in more high-margin blade servers, significantly higher than rival IBM's (NYSE: IBM  ) second-place showing at 28% of the market. More high-end hardware sales present better opportunities for HP to promote its services and software offerings, which are key areas new CEO Leo Apotheker is targeting.
  • After Cisco's (Nasdaq: CSCO  ) decision to get more aggressive in the server space, HP fired back by beefing up its own networking line. So far it looks like HP has more to win by capturing networking share than Cisco is gaining from its server entry. HP's "Catalyst for Change" program has been offering aggressive discounts for customers trading in Cisco gear. While Cisco might trivialize the threat, its 7% decline in switching last quarter illustrates the pressures it's facing.
  • HP's valuation is undoubtedly compelling. Not only does the company trade for a P/E of only 10.5 its trailing earnings, but if you gaze into analysts' crystal ball, HP is trading for only about 7.2 times earnings in 2012. That's pretty cheap for a company targeting adjusted earnings growth of 11% annually through 2014.

What to watch for: The bad

  • One of the key reasons PCs are still growing in unit terms is the emerging middle class in countries like China. Unfortunately for HP, missteps in handling a recent defect in NVIDIA (Nasdaq: NVDA  ) graphics cards on its computers led to the company offering extended warranties and compensation. Chinese consumers complained of HP treating them with worse service than Western consumers, and HP's market share appears to have been cut in half as a result. Tone-deaf moves like HP's handling of its China market don't point to a bright future in not only its PCs but broader initiatives in other consumer-facing efforts.
  • Speaking of HP's consumer-facing efforts, the company is now attempting to put webOS, which it acquired when it bought Palm, onto smartphones, tablets, and even PCs. webOS was initially unsuccessful under Palm's wings because it didn't have the critical mass to compete with Apple's (Nasdaq: AAPL  ) massive App Store or Android's staggering growth, which was fueled by its free distribution model to manufacturers. Since HP acquired Palm, the gap in content between webOS and other mobile operating systems has only increased. Gaining significant market share in mobile markets seeing the most growth, like tablets and smartphones, should prove to be an extreme uphill struggle for HP.
  • Incoming CEO Apotheker has made it very clear he wants to beef up the company's research and development and further target high-margin software sales, which contribute only 3% of HP's revenue. However, this focus could prove destructive to HP's bottom line or balance sheet in the short term. On the R&D side, HP spends only 2.4% of its revenue on research. Compare that to the 6% spent by IBM, which is the model for IT firms looking to broaden into software. If HP doubled its R&D to match IBM on a total spend basis, it'd reduce operating income by 23%. More troubling might be that HP's underinvestment in innovation has caused the company to overspend in key areas like storage. HP was forced to engage in a wild bidding war with Dell over storage specialist 3Par last year because of holes in its storage offerings. Other storage players like EMC (NYSE: EMC  ) and IBM had developed solutions in-house and were able to sit out the escalating series of rising premiums.

Final thoughts
HP is a company that's a very attractive value, but that still faces significant threats and a need for more investment into its business to keep up with competitors. The best way to stay ahead of these challenges is to be aware of the pressures facing the company, and keep up with the news surrounding HP. The Motley Fool recently introduced a free My Watchlist feature that allows users to stay ahead of the curve and receive up-to-date news on companies like HP or any of its competitors. To get up-to-date HP news and analysis, add the company to your watchlist today:

Eric Bleeker owns shares of NVIDIA. Apple and NVIDIA are Motley Fool Stock Advisor picks. Motley Fool Options has recommended a bull call spread position on Apple. The Fool has written puts on Apple, has created a bull call spread position on Cisco Systems, and owns shares of Apple, EMC, IBM, and Oracle. Motley Fool Alpha LLC owns shares of Cisco Systems. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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