How HP Stock Could Bring Double-Digit Upside for Buffett

Key Points

• Many consider HP stock a dying business, as a large portion of the company's revenue comes from printing equipment. 
• If management decides to dump its segment in the contracting industry, the dilution of this business could bring a double-digit rally in appreciation or special payouts.
• Strong financials allow for reinvestment into growth areas like emerging markets, with populations looking at HP for an affordable PC solution.

Shares of HP Inc. NYSE: HPQ have recently broken out of their previous $27 to $30 a share channel; of course, this price action had been relatively justified. The company's recent quarterly financial results show how the comeback in the personal computer (PC) space could mean good news for the company's future, which is also good news for Warren Buffett.

After announcing a significant stake in HP stock back in 2021, some investors had a hard time understanding what the oracle of Omaha saw in the ‘dying’ computer company. Some bear cases have gained traction for the company, as printers and office equipment represent a large segment of HP’s revenue. Everyone can agree that with changing hybrid work settings, printers and office equipment could very well be a contracting industry.

However, HP's financials show a resilient position that could help management quickly pivot into what already makes the company money and even start to venture into other newer growth areas to boost shareholders' returns. This plan would be welcome news for activist investors like Buffett.

Reviving Shareholder Interest: HP's Printing Business as the Key Strategy

With over $460 million in free cash flow (operating cash flow minus capital expenditures) in the past quarterly financials, HP management could try to invest in the bullish outlook for the personal computer industry, especially with technology peers like Intel Co. NASDAQ: INTC and Nvidia Co. NASDAQ: NVDA breaking through current semiconductor ceilings.

Personal systems, including PCs, grew revenues by as much as 3% over the past year. However, net printing segment revenues declined by 8% during this time, led by heavier 12% contractions in HP’s commercial printing business.

Because this business generated up to $8.7 billion in revenue, it would be beneficial for investors to wonder how much the disposal of this segment would mean as a potential payout. However, to value this business, investors need to find a comparable printing business to start developing a rough idea.

This is where Xerox Holdings Co. NYSE: XRX comes into play. The company’s financials show up to $6.7 billion in sales for the past 12 months, and markets are now willing to pay a price-to-sales (P/S) multiple of 0.8x today.

To be conservative, despite HP having more enormous printing revenues, investors can slap a lower 0.7x P/S multiple on HP’s $8.7 billion revenue, which would become roughly $6.1 billion in a theoretical valuation. This will represent approximately a $6.2 boost in either stock appreciation or a special dividend payout per share.

Whichever way management decides to reward shareholders on this potential strategy twist, a $6.2 per share boost would imply a return of 17% from today’s stock price.

How HP's Financial Strength Fuels Its Growth Investment Potential

What initially attracted Buffett to HP may be the one thing that helps other investors name the stock their wealth compounder in a few years. The company's financials show a gross margin of 22.1%, which enables management to allocate capital smartly.

How can investors check for the truth behind this statement? Looking over the returns on invested capital (ROIC) rates will reveal a five-year average of just over 30%, which is incredibly high for a business that had been termed ‘dying’ by many.

Because annual stock price action tends to follow the long-run ROIC rate, HP can set itself up to become a compounder for those savvy enough to understand that dilution of the printing business may be a good idea. Even if this disposal never comes, the company retains so much of its cash flows that it could allow management to start investing in other growth areas.

One of these could be in emerging markets. Because HP sells more affordable PCs than Apple Inc. NASDAQ: AAPL, it could make a significant splash in emerging markets like India and Africa. As middle-class populations grow, HP’s quality and price points could help the company gain substantial market share in these regions.

Known for taking the long view, it shouldn’t surprise investors to see this international trend as one of Buffett’s thesis for backing HP stock the way he did.

So-called ‘smart money’ may have already noticed this potential breakout, as those at the Vanguard Group saw it fit to boost their positions in the stock by as much as 2.6% as of May 2024, bringing the asset manager’s net investment up to $3.6 billion today.