Is Hewlett-Packard Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Hewlett-Packard (NYSE: HPQ  ) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell HP's story, and we'll be grading the quality of that story in several ways:

  • Growth: Are profits, margins, and free cash flow all increasing?
  • Valuation: Is share price growing in line with earnings per share?
  • Opportunities: Is return on equity increasing while debt to equity declines?
  • Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at HP's key statistics:

HPQ Total Return Price Chart

HPQ Total Return Price data by YCharts

Passing Criteria

3-Year* Change

Grade

Revenue growth > 30%

(8.4%)

Fail

Improving profit margin

(140%)

Fail

Free cash flow growth > Net income growth

16.1% vs. (136.5%)

Pass

Improving EPS

(144.6%)

Fail

Stock growth (+ 15%) < EPS growth

(48.8%) vs. (144.6%)

Fail

Source: YCharts. * Period begins at end of Q2 2010.

HPQ Return on Equity Chart

HPQ Return on Equity data by YCharts

Passing Criteria

3-Year* Change

Grade

Improving return on equity

(161.3%)

Fail

Declining debt to equity

113.4%

Fail

Dividend growth > 25%

81.5%

Pass

Free cash flow payout ratio < 50%

11.2%

Pass

Source: YCharts. * Period begins at end of Q2 2010.

How we got here and where we're going
The world's leading PC manufacturer earns only three out of nine passing grades, and two of those are dividend metrics -- what does that tell you about the state of the PC industry? HP's revenue and net income have been decimated over the past few years by slackening computer demand. Consequently, HP tacked on a fairly large amount of new debt in an effort to spend or buy its way out of the problem, which has also cost it a failing grade. Is there any hope left for HP today?

HP's shares tumbled as much as 14% recently after the company issued another disappointing earnings report. Moreover, HP has failed to succeed in the enterprise sector, and that segment's revenue fell more than 8% in the most recent quarter. Fool contributor Matt Thalman notes that CEO Meg Whitman's turnaround plan involves shifting HP's PC-centric business model to a more enterprise-focused structure; but if the company can't even produce growth there, then where can it grow? "Focus on the enterprise" seems increasingly the mantra of a consumer technology dinosaur, and HP is hardly alone in the desire to gain more corporate customers.

My fellow Fool Sam Mattera notes that HP's printing business, which accounts for 21% of its total revenue, remains its most profitable business segment. However, Cerner provided one rare ray of hope when it decided to employ HP's analytical platform. HP has also cut 11,700 positions to save on operational expenses, and more cuts are likely in the offing. HP's new Moonshot low-power servers might also prove appealing, but they run the risk of being sidelined, as many midsize businesses move into the cloud for their connected infrastructure. Growing demand for HP's converged storage solutions should also provide a boost.

With shares trading at 5.5 times trailing 12-month free cash flow, HP looks like a screaming bargain, but a stock so cheap can just as easily be a value trap. Investors would be taking somewhat of a leap of faith into HP's future, which has nothing resembling a sure thing just yet.

Putting the pieces together
Today, HP has few of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.

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