Which of These Closely Compared Companies Is Moving in the Right Direction?

Dell and Hewlett-Packard are two closely compared competitors, operating in many of the same industries. However, in terms of operational approach and company direction, the two are about as different as they come. Now, with both companies reporting earnings in the last week, which is a better buy?

Similar Yet Different

Like I said, although compared, HP and Dell are very different. For one, HP is much larger, and has four massive segments in which its revenue is distributed somewhat fairly. Dell relies mostly on its PC segment, and also its enterprise hardware business, which made up 86% of the company's Q2 revenue.

HP has been one of the Dow's top performers of 2013. Meanwhile, Dell's stock gains have stalled following a very public buyout bidding war from the likes of Michael Dell, Carl Icahn, and the investment firm Silver Lake. And while it does appear that Dell will be purchased at some point in the future, we can not assume the buyout will occur, as deals often fail to materialize and these events can take a turn for the worse rather quickly.

A Fundamental Look

I am looking at the quarters from both HP and Dell, comparing them both, and then determining which company has the most upside based on valuation and fundamentals alone. Therefore, let's look at some key metrics for each company, and how these fundamentals compare over the previous year.

In case you're having trouble in reading or following the chart above, allow me to simplify it. First, HP posted a year-over-year loss in every single major revenue category. HP also spent less on SG&A and R&D compared to the previous year. Seeing as how most technology companies spend money in order to innovate, HP's lack of investments appear to be a sign of playing it safe.

Dell is growing in three categories, and its decline in PCs is less than half of HP's year-over-year decline. Also, Dell has greatly boosted its spending, especially in R&D. Thus, Dell is making investments and is spending money in order to make money in the future.

A Difference In Operational Approach

Combined, you can really see the difference in operational approach between these two companies, when stacked side-by-side. HP's stock has been rewarded in the last nine months as the company cuts costs to focus on operating efficiency. In particular, cash flow is a big value driver for HP, and in this quarter, operating cash flow of $2.7 billion represented a year-over-year loss of just 6%, which is less than revenue declines.

On the other hand, Dell's operating income fell a whopping 71% year-over-year to $205 million, which is reflective of the company's plan to gain market share in its largest segments. In particular, the company cut the retail price of PCs in an attempt to gain market share, which was effective. Therefore, an investment decision comes down to operational preference, and forward looking expectations.

Where To Invest?

If all goes to plan, and Dell is acquired, then limited upside would exist. But like I said, takeovers fall through all the time, and Dell's buyout process has been anything but smooth. Therefore, with both companies paying a dividend of 2.3%, trading at 0.42 times sales, and operating in many of the same industries, I still like Dell more than HP - even with the acquisition overhang.

At the very least, Dell trades flat and becomes a dividend investment in an unstable market until it's taken private. But if not, then I like the long-term strategy of investing in R&D and their attempt to steal market share to produce long-term growth. I also like that Dell is seeing year-over-year gains in many of its segments despite the overall industry producing year-over-year losses.

In the case of HP, its focus on its enterprise segment is not paying dividends, as none of its major segments are seeing growth. Moreover, the company has backed out of its guidance to produce top-line growth by 2014, and I am not sure that its production of large free cash flow is enough to validate an investment in the declining company.

Final Thoughts

In the end, when I invest in technology, I want to see innovation, R&D expenses, and signs of growth. With HP, I see none of the above. Where's the innovation; where's the R&D; and when will the company ever see growth? Personally, I can not answer any of those questions.

Now, I'm not suggesting that Dell is a homerun investment: The PC industry itself faces a challenge with double digit year-over-year declines. But in terms of valuation, I think the company is attractively priced, and is moving in the right direction with its strategy, whether taken private or remaining public.

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The article Which of These Closely Compared Companies Is Moving in the Right Direction? originally appeared on Fool.com.

Brian Nichols has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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