HP's Fall Explained in 1 Chart

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"People do not get what they want or what they expect from the markets; they get what they deserve ... Mr. Market doesn't give a hoot. He's got a 'Capitalism at Work' t-shirt on and a sledgehammer in his hand."

-- Bill Bonner

Stocks create and destroy value two different ways. One is determined by how much profit a company earns. The other is driven by changes in how the market values those profits. Sometimes, the market is excited and values profits at a huge premium. Other times, it gets depressed, and changes its mind. That's really all there is to the stock market.

That simple explanation also tells us a lot about Hewlett-Packard's (Nasdaq: HPQ  ) plunge in recent years. HP shares fell 13% yesterday, and are down 33% year to date. They're down 70% in the last five years, 80% in the last 12 years.

What happened? This chart tells the story.

Source: S&P Capital IQ.

HP's earnings have actually done pretty well in the last decade -- they're the red line in this chart. Earnings per share doubled from 2000 through the second quarter of this year. Yes, they've stumbled a bit lately. But that doesn't explain an 80% nosedive.

What matters far more is the blue line, showing HP's price-to-earnings ratio. That's how much the market values HP's earnings. And it's gone straight down over the last 12 years, from more than 50 in 2000, to 20 in 2008, to about six today. That's one of the most severe compressions in valuation multiples you might ever see.

The vast majority of HP's problems are not about poor earnings per se. They're about the market's plunging confidence in those earnings, driven by a fear that they'll keep falling in the future.

Maybe that's rational, maybe it's not. Either way, HP shareholders, meet Mr. Market's sledgehammer.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (2) | Recommend This Article (8)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 05, 2012, at 10:20 AM, prginww wrote:

    Does anyone out there take HP seriously? David Packard's incredible company now sells ink, ink and lots of ink. Wow! And why would anyone expect the Fiorina - Aptheker - Whitman technological ink wonder to have a high PE ratio?

    The last time I bought an HP product and said wow was the Original Laserjet II. Duh!


  • Report this Comment On October 05, 2012, at 6:51 PM, prginww wrote:

    I have HP's Photosmart C4780 printer, which is terrific and was not expensive. It was bought several years ago and I still love it.

    Recently I bought a laptop from them which was in a promotion. It's fine except I have a problem with the battery charging when plugged in, which their technical support team is helping me correct by sending me a new adapter. Their technical support is great. I'm an elderly lady but I know how to work a computer and their support is excellent, which is important.

    I don't need a BMW to get me places as long as a Ford or Chevvie is comfortable and gets me there and is less expensive. sillyjack

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