Investors Larry Pitkowsky and Keith Trauner of the $70-million GoodHaven Fund (GOODX) also studied HP as shares declined this year. What they found was a company with a No. 1 position in servers and cash-generating businesses in software, services, and printers. They assumed HP's operating earnings over the past few years should have been 20% less than what was reported, in part because former CEO Mark Hurd was starving the company of R&D to satisfy Wall Street. So instead of almost $5 in operating earnings per share this year, HP will really earn more like $3.50 to $4 per share. That still works out to a mid-single digit price-to-earnings ratio. "What are you risking?" asks Trauner.
Former partners of Bruce Berkowitz at the Fairholme Fund, Pitkowsky and Trauner have long histories buying stocks that others avoid. During last decade's tech bubble they held insurers and energy companies as the Nasdaq rocketed upward. Their new GoodHaven fund is pounding competitors, rising almost 7% since opening this year.
The two talk about another way to look at price-to-earnings ratios. Instead of dividing price by earnings, you can do the opposite: divide earnings by the stock price. That produces an "earnings yield" and gives investors an idea, in theory, of what each dollar invested should return if earnings never change. HP's earnings yield is almost 20%.
"In a near zero percent world," says Trauner, "we think we're approaching a 20% earnings yield on something where there really is a very large institutional base of business."
Of course, a high earnings yield is meaningless if earnings fall off a cliff. That would create a value trap as declining businesses get cheaper and cheaper. But from what Trauner and Pitkowsky can tell, HP's businesses aren't undergoing permanent declines. The services business contributes almost 40% of profits and is anchored by large, and long-term contracts with customers. HP is borrowing a page from IBM (IBM) and building off its No. 1 position in servers into higher-margin software and services. And even though competitors are beating it in the low-priced printer market, HP is preserving profits by moving into higher-end, higher-margin printing devices.
HP's taking a $1 billion charge to shut down its mobile operating system's devices business. But Trauner and Pitkowsky don't see HP's cash flows drying up anytime soon. They expect the value of HP to rise over time, and once things are sorted out, the stock to fetch more than $40.
HP stock doesn't look like it could earn a quick buck like Apple's. Economic issues in Europe, where it does a lot of business, and sluggish sales in the U.S. are weighing on the company. But that's exactly why some investors think the stock is a deal today.