The recent acquisition of an 11% stake in HP Inc. (NYSE: HPQ) of Berkshire Hathaway (BRK.A) (BRK.B) should not be taken lightly, especially in the current circumstances. It was one of the greatest monetary as well as a percentage stake in a company that Buffett has created in recent years. Today, the stock price sits exactly where Berkshire acquired its stake – a great opportunity for those who believe in the insight of the world’s largest investor. The fact also that the participation was announced on April 7 – 6 weeks after the start of the Ukrainian war – means that Buffett and his associates have not been deterred by the economic consequences of the war and the spiraling of the inflation. Why?
A solid defensive company that has stood the test of time
There are times for exciting growth businesses, and there are times for boring old-school businesses. In turbulent times, boring old companies always win. HP has been a traditional technology company for years, selling computers and printers to individuals and businesses. In the first fiscal quarter, ending January 31, 2022, the company reported that 72% of its revenue came from personal systems – which are mostly laptops and desktops. 28% came from printers and printing supplies. These are low gap sectors but HP has managed over the years to create and maintain a leading position in 57 countries in printing or PCs. This is no easy task, especially given how simple and weak the technology is to make computers and printing equipment.
HP was able to achieve its success by acting as a hybrid between a technology company and a consumer goods company. It has maintained a high level of investment in research and development – devoting 2.5-3% of its revenue to R&D, a total of $5 billion over the past three years. It has controlled its costs, generating gross profit margins of between 18% and 20% over the past three years, and has maintained a tight grip on working capital management, helping it generate strong cash flow from exploitation. But the main competitive advantage that HP created was the massive global supply chain and global distribution reach that it created, which enabled it to manufacture products at low cost and deliver them efficiently and in sweetness to mass consumers. HP operates in 90% of the Earth – selling its products in 170 of the world’s 193 countries. It has 250,000 channel partners facilitating reach into different markets. And the billions the company spends on R&D won’t be wasted; the company owns 27,000 tantalizing patents. The company is developing more innovative products, such as gaming equipment, to compensate for weak or declining volumes of traditional computing and printing equipment.
The valuation is compelling and provides investors with a buffer
Expected second quarter financial results on May 31, 2022 will provide investors with valuable insight into how business fared during the critical February-April period when all hell broke loose economically in the world. It is reasonable to expect that revenues and profit margins have almost certainly shrunk from the second quarter of 2021. This would continue the deflationary trend of the work-from-home COVID lockdown boom that has boosted home buying personal computing and printing equipment. But also the combo hit in the second quarter of the war in Ukraine, the lockdowns in China and spiraling inflation will all certainly have a direct impact on business.
All of these negative factors are priced in by investors, causing the stock price to decline 17% over the past five weeks, and at the current valuation of 6.4x P/E and 5.9 times market capitalization to operating. cash flow. Dell’s largest company trades at roughly the same 6.5x P/E, albeit with a cheaper market cap for 3x operating cash flow.
Aggressive shareholder returns strengthen valuation metrics. $7 billion was paid out in 2021 from share buybacks and dividends – or 20% of market capitalization. This is one of the main reasons why Berkshire Hathaway would have acquired his stake, as Warren Buffett has always been a strong supporter of share buybacks to increase returns for investors.
An aggressive assumption of halving profitability levels at HP would still make stocks cheap at today’s price, giving today’s investors, including Warren Buffett, a good buffer.