Betting On Or Against Buffett?

Most of last week’s most notable insider buys were made by institutions. Money managers, hedge funds… need to report their activity if they have or acquire a stake of 10% or more in publicly-traded companies.

So, if we are going to focus on institutional activity, we might as well put the spotlight on perhaps the most famous institutional investor of them all. The Oracle of Omaha, Warren Buffett. Buffett’s Berkshire Hathaway acquired more than 11.1 million shares of HP Inc. (HPQ) for a little more than $398.5 million. (1).

Normally, we skip over institutional trades, not because they aren’t good investors, but because most of the transactions are part of a string or prior purchases. In HPQ’s case, this is Buffett’s opening buy. If you look at Berkshire’s history, more often than not, you’ll find the renowned investment company build a position through multiple buys. (2) It would not be surprising to see Mr. Buffett & Co. add more HP down the line.

As you most likely know, HP provides personal computing and other access devices, imaging and printing products, and related technologies, solutions, and services in the United States and internationally.

Berkshire stepped into HP at a cost average of $35.80. As we type, the tech company trades at $38.63 and has a consensus one-year price target of $37.20. Did the mighty investment guru make a mistake, or does Buffett’s team see value where Wall Street doesn’t?

Warren likes to buy things on the cheap. HPQ has some bargain valuations relative to its industry’s averages. For instance, HP trades at 6.67 times earnings (P/E) versus the industry average of 24.5; HP is valued with a forward P/E of 8.35 compared to 23.5 for the industry; HP shares are worth $0.66 per dollar in revenue (P/S) while the industry gets a P/S ratio of 5.1; and HP is priced at 6.7 times cash flow against 19.2 times cash flow for the industry.

Analysts forecast consensus earnings per share of $4.28 this year and $4.41 next year with sales expected to reach $65.74 billion in 2022 and slip to $65.38 billion in 2023. (3) Selling less, but earning more, suggests Wall Street sees HP’s profit margins expanding a touch.

Unfortunately, the most recent quarterly report shows margins could come under pressure as HP’s costs are rising. For example, cost of revenue for the three months ended January 31, 2022 were 80.12% for sales this year compared to last year. That’s not surprising since inflation is driving up prices everywhere. Management is trying to keep costs in check by reducing research and development to 2.45% of sales versus 3% year-over-year. Selling, general, and administrative costs are also slightly lower in 2022 compared to last year, 8.62% of revenue and 8.79% respectively. Overall Total Costs and Expenses were 92.02% of sales this year versus 91.56% last year.

Management did a good job holding the line in the face of rising prices but reducing R&D and marketing could eventually hit the top line in the form of less innovation and advertising driving brand awareness. Inventory isn’t an issue yet but is another line item to keep an eye on. Last year, inventory stood at 50.68% of revenue, that number grew to 52.96% this year despite sales jumping from $15.646 billion to $17.028 billion. We’d prefer to see inventory falling as a percentage of sales as it usually points to higher margins.

In all likelihood, earnings growing as sales slide is most likely a byproduct of share repurchases. Diluted shares outstanding were 1.293 billion in 2021 compared to 1.094 billion this year.

OVERALL: It’s hard to bet against Warren Buffett’s record and HP Inc. (HPQ) has an attractive dividend yield of 2.59%, but HPQ is likely to trade like rush hour traffic, frustrating investors with sputters and stops. The work/school remotely COVID induced PC/Laptop buying cycle may have pushed demand forward a touch, meaning sales could decline as Wall Street expects. The danger is demand slips more than anticipated while costs increase.

It’s not our place, far from it, to say Warren Buffett and Berkshire Hathaway are wrong. However, it’s our opinion that investors who wish to follow Buffett’s lead should have at least a 24-month time horizon, maybe longer.


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