The Investable Beauty of Low Expectations
Back in December, when Microsoft became a selection for the real-money Inflation-Protected Income Growth portfolio, its stock looked to be bargain-priced. How cheap was it? Well, to quote its selection article: "By a discounted cash flow analysis that assumes no growth ever again, the company looks to be worth around $234.5 billion, making its recent market price of $229.9 billion look reasonable."
Microsoft's stock had such low expectations priced into it that it still looked reasonably priced if you assumed it never grew again -- ever. That's low expectations, all right. For the most part, about the only time a company's expectations are lower are if it's actively collapsing or if it's facing down some make-or-break scandal with a high chance of sinking the business.
In yesteday's trading session, Microsoft's stock dropped an astounding 4.44%, on news that personal computer sales were far lower than expected. Predictably, PC maker Hewlett-Packard saw its shares plummet as well, down an astonishing 6.45%, as its shipments were particularly hard-hit. HP's PC shipments dropped by nearly a quarter versus year-ago levels -- far worse than the industrywide 14% drop.
Yet in spite of that plummet, as of yesterday's market close, the iPIG portfolio is still showing a net gain on the Microsoft shares it owns. On top of that gain, the portfolio has already picked up a reasonable dividend payment from Microsoft, increasing its overall returns.
The secret of the iPIG portfolio's investing success with Microsoft? Low expectations. All stocks are priced based on what the market expects from them in the future. The market had already largely priced in a Microsoft flop. When the company delivered on that flop, investors -- like the iPIG portfolio -- who had bought in only because the company had been valued on those low expectations still came out OK.
Going from atrocious to merely very bad
In many respects, Microsoft's story of investing success in spite of bad news could be repeated for Hewlett-Packard. In fact, it was, late last year, on Dec. 21, 2012:
One of the easiest ways to have a better next year is to royally mess up this year. With that in mind, few screwups in 2012 rate worse than Hewlett-Packard's Autonomy acquisition fiasco. Earlier this year, Hewlett-Packard wrote down a whopping $8.8 billion of the $11 billion price tag it paid for the acquisition just last year.
That $8.8 billion shows up as a charge against its fourth-quarter earnings for fiscal year 2012. Hewlett-Packard alleges that the writedown was driven by improperly recognized revenue prior to the acquisition -- essentially, accounting fraud on Autonomy's part. While many wonder whether the magnitude of the alleged fraud was big enough to justify that large a writedown, the one thing that's clear is that it sets an incredibly low bar for the company to clear in 2013.
On the day that piece was published, HP's shares closed at $14.34. Yesterday, after the release of that disastrous PC shipment data, HP's shares closed at $20.88. That's an astounding 45% gain in just under four months, from a company for which the news simply "improved" from being absolutely atrocious to being merely very bad.
Returns like that are nowhere near typical, of course, but they do showcase why it often pays quite well to invest where the market expects the least.
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What's next for Microsoft?
It's been a frustrating path for Microsoft investors, who've watched the company fail to capitalize on the incredible growth in mobile over the past decade. However, with the release of its own tablet, along with the widely anticipated Windows 8 operating system, the company is looking to make a splash in this booming market. In this special premium report on Microsoft, our analyst explains that while the opportunity is huge, the challenges are many. He's also providing regular updates as key events occur, so make sure to claim a copy of this report now by clicking here.
The article The Investable Beauty of Low Expectations originally appeared on Fool.com.Fool contributor Chuck Saletta owns shares of Microsoft and an options position in Hewlett-Packard. He also happened to write this on a Hewlett-Packard laptop. The Motley Fool owns shares of Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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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