With skittish income investors pushing the staid utility
sector to an abnormally high valuation, the conventional way to
play defense in stocks is looking a bit pricey these days.
A less conventional approach is to take a look at battered
stocks from companies that have hit hard times, but that hold the
prospect of getting their mojo back. You get the benefit of a low
valuation in a market that's fighting all sorts of headwinds, and
if you're patient and right, you may eventually book some nice
gains once the fixer-upper is renovated.
Exhibit A in what the street typically calls "fallen angels"
is Hewlett-Packard (
). The computer services and hardware giant has watched a
dizzying revolving door of CEO's the past few years fail to right
the ship. Mark Hurd, who replaced Carly Fiorina as CEO in 2005
after Fiorina's acquisition strategy bombed, left in ignominy in
2010 over some sketchy expense account entries. Hurd was followed
by Leo Apotheker, who was shown the door after less than a year.
Meg Whitman has been in charge since last fall.
Since the Hurd imbroglio, the stock has pretty much cratered,
as seen in this
And for plenty of good reason.
HPQ Earnings Per Share TTM
But the earnings hit seems to be more than baked into
valuation. The current
is about half the average for the S&P 500 and HP's
is close to double the 10-year Treasury rate.
HPQ PE Ratio
That dividend looks to be plenty safe. Both the payout ratio
and cash-payout ratio have bumped up during the travails of the
past few years, but at 18% remain well below the 28% average for
the S&P 500.
HPQ Cash Div. Payout Ratio TTM
What intrigues value investors is that while Whitman is
working on the operational turnaround -- earlier this year HP
announced a 27,000 cut in its workforce by the fall of 2014, with
an expected annual savings of at least $3 billion and is expected
to return to its R&D roots-Hewlett Packard is still churning
out a bunch of free cash. Combine more than $5.3 billion in free
cash for the trailing 12 months with the low stock price and you
have a compelling cash-flow yield to ponder.
HPQ Free Cash Flow Yield
Larry S. Pitkowsky and Keith D. Trauner, co-managers of the
GoodHaven Fund have about 7.5% of their portfolio invested in
Hewlett-Packard, and called it out in their recent shareholder
letter as an example of the sort of turn-around stories they
like. (Goodhaven is just 18 months old, but both co-managers
spent a decade working with Bruce Berkowitz at Fairholme Fund
during the years when it generated the returns that led to
Morningstar crowning it the domestic stock fund of the decade in
"We think of HP as a tough World War II battleship that has
taken a couple of torpedoes broadside, but refused to sink.
Currently under repair, we believe this vessel will be returned
to useful service by a new board and CEO, who seem intent on
returning to basics, reinvesting in R&D, and using
still-copious cash flows more intelligently to strengthen the
business and shareholder returns."
Not everyone is convinced. In late September, Jeffries
downgraded the stock to underperform (code for sell). But that's
a quarter-by-quarter driven analyst talking. Some pretty smart
long-term investors are more in the GoodHaven camp. Seth Klarman
of Baupost Group, and value-meister Michael Price, of MFP
Investors hedge fund made sizable additions to their Hewlett
Packard positions in the second quarter. The stock is Baupost's
second largest, behind only BP (
And an important insider is clearly betting on a turnaround.
After maneuvering his way onto HP's board last fall, Relational
Investors head Ralph Whitworth invested nearly $400 million in
the second quarter on Hewlett Packard. That's a statement bet,
not window-dressing. Whitworth paid between $22 and $23 a share.
The stock recently traded near $17, giving fresh investors an
entry point to this potential turnaround at an even better price
than what Whitworth paid.
Carla Fried is an editor for the
YCharts Pro Investor Service
which includes professional