Revenue and Profit Growth: From the chart below we can see that their revenue growth is decent but it isn’t consistent year over year growth. The big decrease from 2015-2016 is due to HPQ completing its spinoff of HPE so we are looking from 2016 and on for this. Their profit levels are also inconsistent, but they are consistently profitable which is great. This isn’t exactly an exciting growth story but sometimes boring is better, especially in investing where boring can lead to companies flying under the radar which means they are more likely to be undervalued.
Free Cash Flow and Long Term Debt: Now we get to what I consider to be the most important aspect of any business, their free cash flow. As you can see in the graph below, HPQ has very good free cash flow levels especially when compared to their long term debt. They can almost pay off their entire long term debt with one year of their free cash flow, and we like to see the ability for long term debt to be paid off with 5 years or less of free cash flow. This of course doesn’t mean the company will pay off all their long term debt within 5 years, it is just a quick way for us to see if they have their debt levels in check from a 1,000 foot view. HPQ having significant free cash flow levels compared to debt makes it much more unlikely for them to get into financial trouble as a company especially with the economy in such uncertain times.
Dividends: HPQ also pays a decent dividend, with a current yield of just tinder 2.7%. When looking at dividends it is important to compare the amount of money they pay out in dividends to the companies free cash flow. This ensures the company's ability to actually pay the dividend and helps investors avoid dividend traps. As you can see from the chart below, HPQ has no issues affording their dividend payments. We can reasonably assume the dividend payments are safe and they might even increase in the future as the company has no issue affording them, and they have low debt levels. This is one way HPQ likes to reward shareholders and now we are going to look at the other way they have been rewarding shareholders.
Shares Outstanding: HPQ has been buying back a very large portion of the shares outstanding as shown in the graph below. This is amazing for shareholders for a number of reasons. For starters, your position in the company increases without having to buy additional shares yourself. Also, if their revenue and profit stays stagnant, but they are buying back shares, their earnings per share (EPS) will increase as there are less shares outstanding. This increases the likelihood of their share price increasing because in order for the PE to remain the same with less shares and the same profit the price would have to increase. Another bonus is that they save the dividend payment on all the shares that they buy back. This means that if their dividend payment per share stays the same and they keep buying back shares, they are going to use less and less of their free cash flow on dividend payments. This leaves room for them to increase the dividend payments, pay down more debt, or buy back even more shares, all of which are excellent for shareholders especially since the company is not trading at lofty valuations.
Valuation: We are going to be conservative with our estimates and do a 10 year analysis for HPQ to see what we come up with for our bear, base, and bull case. For all cases we required a 13% annual return rate. The reason for this is that the S&P500 averages about 10 percent annual returns over long periods of time so to take on the risk of holding an individual company, we require a higher rate of return to give us a margin of safety.
Bear Case: In the bear case we assume -2% revenue growth for the next 10 years which gives us a terminal revenue of about 53 Billion. We assumed an average profit margin of 3.5% and free cash flow margin of 5.5%. We assigned ending P/E and P/FCF multiples of 5.
Base Case: In the base case we assume 0% revenue growth for the next 10 years which gives us a terminal revenue of about 64.86 Billion. We assumed an average profit margin of 4.5% and free cash flow margin of 6.5%. We assigned ending P/E and P/FCF multiples of 7.
Bull Case: In the bull case we assume 2% revenue growth for the next 10 years which gives us a terminal revenue of about 79 Billion. We assumed an average profit margin of 5.5% and free cash flow margin of 7.5%. We assigned ending P/E and P/FCF multiples of 9.
Fair Value and 10 year price targets:
The fair value we got for our bear case was $17.38 with a 10 year price target of $36.80.
The fair value we got for our base case was $25.81 with a 10 year price target of $58.59.
The fair value we got for our bull case was $37.37 with a 10 year price target of $90.18.
**Important to keep in mind this would be the adjusted price with dividend payments added back into the stock price as dividend payments are subtracted from the stock price.**
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DISCLAIMER: We are not financial advisors. We are just giving our opinions. Everything in this article is for entertainment purposes only. Do your own due diligence before making any trading or investing decisions.