Hewlett-Packard Needs to Make 1 Big Change to Return to Growth

HP has done very well for stockholders over the last year, but without this one change the honeymoon could be over.

Mar 4, 2014 at 8:30PM

When a troubled company returns to its former glory, investors can reap outsized returns. Hewlett-Packard (NYSE:HPQ) investors have been forced to endure a bumpy ride over the last 12 months, but the stock is still up nearly 50%. The stock's return in the face of challenges in virtually every business HP competes in is nothing short of amazing. However, if the company hopes to keep investors happy, there is one big change that still needs to be made.

The Big Data deluge
One of the big themes mentioned across the technology universe is the idea of Big Data. This term essentially means that tons of information is being created by social networking, transactions, customer service interactions, emails, Internet searches and more.

There might not be a bigger generator of Big Data than Apple (NASDAQ:AAPL) users. In the last quarter alone, the company shipped over 50 million iPhones, and over 25 million iPads . While this is impressive, it's the huge usage generated by these devices that investors should be aware of.

If you don't believe that Apple users dominate the field when it comes to generating data, consider that at the end of last year, Apple's iPhone and iPad devices generated more than 50% of usage share in the U.S. By comparison, rival Samsung's devices generated just under 24%. As devices like smartphones, tablets, and wearable tech continue to grow, companies have a hard time combining this data into something useful.

Of course to handle this data means having someplace to store it, which is a hotly contested field that HP and EMC Corporation (NYSE:EMC) compete in. EMC's storage business, its Pivotal Labs acquisition, and its VMWare ownership, place the company in prime position to benefit from Big Data. The combination of these traits allowed EMC to grow revenue by 11% in the last quarter, whereas HP's enterprise performance was less than inspiring.

HP's storage revenue growth was flat year-over-year, and its Enterprise Group revenue increased just 1%. On the software side of things, HP's investments didn't help the company much, with software sales actually declining by 4%.

The point is, if HP is going to benefit from Big Data going forward, the company needs to make a change.

Is this a symptom...
One way to measure a company's performance is by looking at the company's operating cash flow growth. Investors looking for signs of life from a troubled company can sometimes spot cash flow improving as a sign of good things to come.

However, the cash flow statement isn't without its share of additional non-cash line items. A way I've found to generate an apples-to-apples comparison is by using core operating cash flow (net income + depreciation).

Using core operating cash flow, we find that HP once again lags EMC. EMC reported operating cash flow increased by almost 9% over the last 12 months. On the other end of the spectrum, Apple reported a just over 3% increase. HP fell in-between these two peers with an operating cash flow increase of just under 6%.

...of this problem?
With lackluster enterprise growth and middle of the road cash flow growth, what is the big change that HP needs to return to growth? To be blunt, HP needs to invest far more in research and development.

It's rare in the technology field for a company to stay on top for long without a significant commitment to R&D. EMC is proof, as the company continues to generate respectable growth and spends about 11% of its revenue on R&D. If you don't believe R&D is critical to success, consider that Apple consistently spends just over 2% of revenue on R&D, and for several quarters analysts have questioned if the company's best days are behind it.

HP spent just under 3% of revenue on R&D in the last quarter, and for the company to regain its former glory that is just not enough. Microsoft has returned to growth by consistently spending at least 10% on R&D (11% last quarter). IBM spent 6% of revenue on R&D last quarter. Oracle routinely spends at least 13% of its revenue on this all important expense.

As you can see, HP is playing a dangerous game of hoping its relatively small R&D commitment turns out products that will keep the company moving in the right direction. However, with almost half of the company's divisions reporting revenue declines, HP needs to do more.

The stock is up almost 50% in the last 12 months because things weren't as bad as some feared. If HP investors are to continue enjoying respectable returns, the company needs to invest in future product development. Without this commitment, the honeymoon with HP stock may not last very long.

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Chad Henage owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and EMC. 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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