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Each week, Motley Fool editors cull a top stock idea from the pitches made on CAPS, The Motley Fool's 180,000-member free investing community. Want your idea considered for this series? Make a compelling pitch on CAPS with a minimum length of 400 words. Want to follow our weekly picks? Subscribe to our RSS feed or follow us on Twitter.

CompanyHewlett-Packard (NYS: HPQ)
Submitted By:truthisntstupid
Member Rating:87.98
Submitted On:11/12/2011
Stock Price at Recommendation:$28.02

Hewlett-Packard Profile

Star Rating***
HeadquartersPalo Alto, Calif.
IndustryTechnology
Market Cap$55.7 billion
Industry PeersDell (NAS: DELL)
Apple (NAS: AAPL)
IBM (NYS: IBM)

Sources: S&P Capital IQ, Yahoo! Finance, and Motley Fool CAPS.

This week's pitch:

First, give credit where credit's due. Thanks to dumberthanafool for his blog
http://caps.fool.com/Blogs/my-detailed-pitch-for-buying/668067No. commentsForm

[Editor's note:dumberthanafool'sblog post follows. You can also read it atCAPS.]

So we'll see on this one. I think I failed to blog about it when I bought it, though I shortly thereafter posted a bunch on an article one of the Fool writers wrote. The basic pitch is as follows:

1) Macro-misconception: I think PCs are not totally dying, and HPQ is a leader.

2) Micro-misconception: But what if they are? Well, PCs are actually only 30% of HPQs revenues anyway, but I think the co is being treated as if that is ALL of HPQ's business, because that is how the public, and investors think of the company.

3) Cheap: The stock is down nearly 50% from highs, trading at absurdly low basic metrics of P/E (6.1 forward) and FCF (4.7).

4) Pessimism: The reason the stock is down is because of fear about item 1, above, but also because of uncertainty surrounding the Hurd departure, followed by the disastrous year of [former CEL Leo Apotheker], and his idiotic decision to split the PC business and buy Autonomy at a wildly inflated valuation. Shareholders recognize FCF waste when they see it, and do not believe HPQ's FCF is worth its full value.

5) A New Day, Unrecognized: But wait. [Meg] Whitman is the new CEO. She swiftly reversed the [idiotic] decision to sell off the PC business. More importantly, a company is a new company when it gets a new CEO. This is true when a good one leaves. But, it is ALSO TRUE WHEN A BAD ONE LEAVES. HPQ is priced as if [Apotheker] is going to keep making enormously risky bets and wasting FCF. I think Whitman is not going to do so, as evidenced by her decision to reverse the PC sale. The story on her is not yet written (and she did buy Skype for [eBay]), but as cheap as the stock is, I'm willing to give her the benefit of the doubt.

6) Valuation, FCF: On a free cash flow basis, starting at the $9billion FCF earned in the TTM, this company is more than 30% undervalued. That calculation assumes a 12% discount rate (pretty conservative), and NO MORE THAN 2% FCF GROWTH, EVER (but non-decline, too). So, if HPQ can grow FCF faster than 2% for the next five years, say, then it's vastly more undervalued even than that. Even if it has an unsteady free cash flow and declines in some of the next few years, while gaining in others, for an aggregate 2% annualized gain, it's 30% undervalued.

7) Valuation, Enterprise Value: My enterprise value calculation yields a purchase price for the company of $67billion, about 20% above the current market capitalization. I view this as a flawed metric because it incorporates market capitalization (so if that's too low, then it's off). So I think this is at the very low end of HPQ's enterprise value.

8) Profitability Metrics: A [DuPont] Analysis shows this is a company that is stronger, not weaker, than it was six years ago. Modestly increased leverage is not only reasonable, but prudent, given extremely low interest rates at this time.

Cheers. Happy to hear if I'm wrong about anything.

[Editor's note: Now back to the pitch.]

Now for a look at a few fundies. This is actually funny.

In spite of all the green thumbs I see, there must be enough negativity to cause HPQ to have only a 3-star CAPS rating, and as is often the case, once again I find myself at odds with the herd.

This is going to be short because I have to go back in to work tonight in a few minutes. But it shouldn't take long.

Did I say this was ridiculous?

This company's net margin is at a 10-year high.

Return on equity? At a 10-year high.

Net income? At a 10-year high.

Revenue? At a 10-year high.

Operating margin? 10-year high.

EPS? 10-year high.

Book value/share? 10-year high.

Asset turnover and return on assets? At the upper end of their 1-year range.

ROIC? It's only been higher one year out of the last 10 years.

SG&A expenses are at a 10-year low.

Share count in the TTM was listed at Morningstar.com as 2.194B.

Share count has been steadily decreasing since 2003. There were 3.063B then.

Oh, the debt...[we'd] better look at the debt. Don't forget the debt! YOU worry about it.
ME...I see interest coverage of 32.5 and realize it isn't exactly a problem.

Dividend yield is 1.5%, and dividend payout ratio is a scant 8%.

The last time I made a pick with numbers like that it was [ACE Limited (NYS: ACE) ], which was only 5% off a 10-year high.

It has done quite well.

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At the time this article was published The Motley Fool is investors writing for investors.Dan Dzombakhad no position in any of the companies mentioned in this article. Pitches must be compelling, made in the past 30 days, and be at least 400 words.The Motley Fool owns shares of IBM and Apple. Motley Fool newsletter services have recommended buying shares of Dell, eBay, and Apple and creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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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