Not every stock in Berkshire Hathaway's portfolio was personally chosen by Warren Buffett, but those he's trusted to make investments follow the same basic principle that helped turn Berkshire into one of the largest companies in the world: Buy good companies with durable competitive advantages at reasonable prices.
Many of the stocks in Berkshire's portfolio look like great buys, but others are less appealing. One stock that stands out as a potential dud is HP (HPQ 1.22%).
Key Data Points
The great PC normalization
HP is one of the leading manufacturers of PCs. During the first two years of the pandemic, sky-high demand for PCs, electronics, and gadgets triggered a renaissance for the PC industry. Coupled with high prices due to supply chain shortages, HP enjoyed soaring PC revenue and margins.
In fiscal 2021, HP's personal systems segment grew revenue by 14.1% year over year to $20.1 billion, and it booked an adjusted operating margin of 7.2%. That's an unusual result for a few reasons. First, selling PCs just isn't a growth business. PC unit shipments peaked in 2011 and declined up until 2019. With the proliferation of smartphones, a PC is no longer a necessity for some consumers.
Second, there's no good reason why HP's PC business should be that profitable in a normal environment. Outside of the high-end of the market, there's next to nothing differentiating PC vendors. A mainstream laptop from HP will be very similar to a mainstream laptop from Dell or Lenovo. Unless you're Apple, selling PCs is a low-margin affair.
Last year, and continuing this year, the PC market began shifting back to its pre-pandemic ways. Global PC shipments plunged 30% year over year in the first quarter, adding to a decline in 2022. An oversupply coupled with weak demand is driving shipments down to the lowest level in a very long time. Inventories will eventually be worked through, but annual shipments are almost certain to settle significantly below pandemic-era levels.
If the PC industry returns to being a mostly flattish affair, with little in the way of annual shipment growth, the days of fat profits for HP's PC segment will officially be over. Already, the situation has deteriorated. Adjusted operating margin for the personal systems segment fell to 5.4% in the first quarter of fiscal 2023, and sales dropped 24% year over year.
Cheap for a reason
Analysts expect HP to report adjusted earnings per share of $3.35 for fiscal 2023. Based on the current stock price, the price-to-earnings ratio sits just under 9.
The problem for HP is that its growth prospects are minimal. There's no reason to believe PCs will be a growth business after the oversupply situation works itself out. And the other part of HP, printing, won't be driving growth either. HP's printing revenue has been trending downward, and while the business is highly profitable thanks to high-margin supplies, the best-case scenario is a stable business in the long run.
Some stocks are cheap for a reason, and HP is likely one of them. Will HP be a bigger, more profitable company 10 years from now? That seems doubtful to me. The lack of any kind of growth story is reason enough to stay away from this Buffett stock.
