by Daniel Putnam | November 21, 2012 10:25 am
Hewlett-Packard (NYSE:HPQ) and Best Buy (NYSE:BBY) are two very different companies, but investors who tried to bottom-fish in either one have learned the same lesson: Stocks aren’t a “value” when their fundamentals are deteriorating faster than their stock prices.
The perils of getting caught in a value trap were on full display on Tuesday, when HP and Best Buy each posted double-digit losses even though the two stocks were already down 47% and 39%, respectively, on the year.
For HP, the catalyst was the disastrous admission that the company was a victim of fraud in its ill-fated 2011 purchase of the British software firm Autonomy. Of all the negative developments that have driven the stock down from its early-2010 high near $55, this one is perhaps the most damaging. Best Buy was hit hard by the news that it missed earnings expectations on a 4.3% year-over-year drop in same-store sales.
But for investors in either stock, these types of headlines should come as no surprise at this point.
The charts tell the story: For three years, both stocks have been on a straight trajectory from the upper left to the bottom right. With a few small divergences along the way, the two companies have traced a remarkably similar path in their race to the bottom. On Tuesday, they closed within 25 cents of each other, with Best Buy going out at $11.96 and HP finishing the day at $11.71.
Unfortunately for both companies, the future doesn’t appear much different than the past.
Let’s take HP first. The stock now has a ridiculous price-to-earnings ratio of 3.3 times 2013 earnings. To put that in perspective, Hewlett shares could gain 97% and still be trading at half of the forward multiple of the S&P 500. This P/E ratio is deceptive, however — not just because there’s no way to tell what the “E” in the equation will actually be a year from now, but also because this low valuation is really all the stock has going for it right now.
Valuations just don’t matter once a company begins to fall behind the technology curve. As CNBC’s Jon Fortt wrote on Tuesday, none of Hewlett’s three divisions are in a position to rescue the company: PCs aren’t selling, fewer documents are being printed and services — long the safety valve for troubled technology firms — are on track for an 11% to 13% decline in revenues in 2013. On top of this, HP has offered no clear plan on how it’s going to escape this morass.
If you’re reading this, you may be among those tempted to take a swing at HPQ after Tuesday’s 12% drop. In the near term, however, there isn’t much of a reason why it should bounce. Institutions will need to clear the name off their books before year-end, and the prospect of higher capital gains taxes will only encourage investors to book losses in beaten-down stocks to reduce their tax bill come April.
This doesn’t mean HP will never again be a buy, however. On very few occasions has a company so large — and unlikely to disappear — been so widely panned by analysts and the media alike. Consider that of the 33 analysts who cover the stock, only six rank it as a buy or strong buy — perhaps an indication that the cycle of downgrades is finally nearing exhaustion.
One sign of this capitulation came from a research note written by ISI Group analyst Brian Marshall, who referred to HP as an “unmitigated train wreck” and apologized to investors for having recommended the stock.
Given how negative sentiment has become, the risk-reward equation may finally swing in favor of owning HP in 2013. For this to occur, three (big) “ifs” have to come together:
If all three events take place, that will be the cue that HPQ may finally be a stock investors can consider. In the meantime, there’s no reason to tie up precious capital betting on a turnaround.
The outlook for Best Buy, which is now at a 14-year low, is even darker than it is for HP. Like Hewlett, Best Buy trades at an insane P/E: 4.5 times forward estimates. But also like HP, there’s no visibility as to how far these estimates could fall in the coming year — especially now that the company is pledging to match the prices of its lower-margin competitors this holiday season.
It’s the old “We’ll sell at a loss but make it up on volume” joke come to life, but this time nobody’s laughing … except maybe Amazon‘s (NASDAQ:AMZN) Jeff Bezos.
Those hoping for a longer-term Best Buy turnaround need to take a closer look at its business. The company operates in an ultra-competitive, economically sensitive and low-margin business, and it’s having its lunch eaten by Amazon, Wal-Mart (NYSE:WMT), and even Costco (NYSE:COST). This is the same scenario that took out Circuit City and has HHGregg (NYSE:HGG) and Radio Shack (NYSE:RSH) on the ropes right alongside Best Buy.
The lesson here is clear: Companies can’t make money selling only electronics from physical locations, and Best Buy is no different — despite its plan to place a greater emphasis on in-store service. Further, the company’s free cash flow — long the No. 1 reason investors own the stock — has begun to turn south, as outlined here by CBS MarketWatch.
Best Buy is operating with an antiquated business model, and there’s no reason to try bottom-fishing either now or at any point in the future. While a buyout may occur at some point, investors need to question whether lenders will provide former CEO and would-be buyer Richard Schulze with enough cash to make it happen. At this point, it’s not a bet worth making.
There’s no doubt Hewlett Packard and Best Buy are tempting at these levels — just as they were 30% ago. Until and unless there’s a clear reason to buy, there just isn’t enough upside to wade into the quicksand with these two companies.
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