Berkshire Hathaway recently announced they now are the proud owner of an 11% stake in PC Maker HP. However, only a small number of people actually understands why the Oracle of Omaha has bought shares in HP. Several articles even state 4 reasons why Warren Buffett’s 11% HP Buy is a bad bet:
- HP’s products lack universal appeal
- Customers do not have an addictive need to buy HP’s products
- HP has no moat
- Buffett lacks superior computer industry insight
Given his track record, Warren Buffet doesn’t buy into a company unless there is deep value to be found. Clearly, Buffet found value in HP Inc. and it would seem the general investment public does not agree. In the article below, I will showcase the bullish scenario for HP and why I am buying shares.
HP Inc. provides personal computing and other access devices, imaging and printing products, and related technologies, solutions, and services in the United States and internationally. The company operates through three segments: Personal Systems, Printing, and Corporate Investments. The Personal Systems segment offers commercial and consumer desktop and notebook personal computers, workstations, thin clients, commercial mobility devices, retail point-of-sale systems, displays and peripherals, software, support, and services. The Printing segment provides consumer and commercial printer hardware, supplies, solutions, and services. The Corporate Investments segment is involved in the HP Labs and business incubation, and investment projects. It serves individual consumers, small- and medium-sized businesses, and large enterprises, including customers in the government, health, and education sectors. The company has been around since their foundation in 1939.
The value in HP Inc. lies in their share buyback program and the mathematics involved in dividing growing earnings on a decreasing number of outstanding shares. At first, we notice several key points that highlight the potential value investing in HP Inc. (HPQ) as per Yahoo Finance:
- With a stock price of $36.78, and given the fact that HPQ has 1.092.205 shares outstanding, this leads towards a marketcap of $38.74B.
- The stock trades at $36.78 (at the time of writing), with a 52-week range of (26.11 – 41.47). HPQ trades at a TTM (forward) PE ratio of 6.61 (8.17) which is significantly below the industry average of 13-15 and below their own historical PE ratio of 9.6. This indicates that HPQ is undervalued relatively to their own price history, the current industry and market averages and the historical industry and market averages.
- HPQ has an annual dividend of $1, which is a dividend yield of 2.72%.
- HPQ is currently implementing a hefty share buyback program and has decreased the shares outstanding from 1,560,000,000 in 2018 towards 1,060,987,000 in Q1 2022, a decrease of nearly 32%.
- HPQ has average free cash flow of $4.382B for the 2018-2021 period, even after buying back on average $1.5B worth of their own shares in the past quarters.
- HPQ has increased their revenues, earnings and margins in the past year and has been profitable. Overall, the fundamentals are rock solid and are worth a buy on their own.
2. SHARE BUYBACKS AND THEIR EFFECT ON EPS
Below is my conservative investment thesis for HP Inc., I have assumed no growth in revenue, earnings and margins in the years towards 2025 as a conservatism and margin of safety are both important investment values. In the past 4 years (2018-2022) HPQ has bought back 500M of their shares for a total value of $14B, or an average of $3.5B and 125M shares per year. In Q1 2022 alone, the company purchase $1.5B of their stock, decreasing the number of shares outstanding by 31M shares. HPQ has a 4 year average earnings of $4.456B, an 2021 earnings even topped at $6.5B. We build our investment theses therefore with 2 possible scenario’s: the conservative $4B in earnings and the recent $6B earnings for the 2022-2025 period. Eventhough analysts expect the Computer Hardware industry to grow with an annual growth rate (CAGR) of 7.6%, we consider no growth in earnings in order to be conservative in our investments. The results are shown below in Table 1. We expect the company to buying back shares at the same rate as shown in history, which amounts to 125M shares annually. We ignore price appreciation of the stock that is bought back because we are conservative in our estimate for the number of shares bought back.