I got a chance to catch up with old colleagues at a tech investment conference this past week. And one topic dominated our hour-long discussion: Now that Dell (Nasdaq: DELL) and Hewlett-Packard (NYSE: HPQ) are trading far from their all-time highs, is either one a bargain? More specifically, how do these two stocks stack up against each other? We couldn't come to an agreement, but now that I've had a chance to compare these two stocks, I think a clear winner has emerged.
To value these stocks, I used eight distinct factors and assigned each factor a relative weighting on a 100-point total scale. Here's the result:
Factor #1: profit margins
Weighting 15 points
Dell's operating margins have fluctuated between 4% and 8% in the past six years, while HP's margins have hovered between 7% and 9%, thanks to a greater emphasis on software and services.
Result...
Dell: 6.5 points
HP: 8.5 points
Factor #2: sales consistency
Weighting 12 points
In a worst case scenario (which we saw in 2009), Dell's sales fell 13%, while HP's fell only 3%. Moreover, Dell was only able to boost sales by 1% in fiscal (January) 2011 to about $61.5 billion, even after incorporating a series of acquisitions. HP's recent sales growth hasn't been especially impressive either, but the company at least has a higher degree of recurring revenue from long-term service contracts.
Result...
Dell: 5 points
HP: 7 points
Factor # 3: free cash flow
Weighting: 15 points
This is distinct from factor #1 because it better incorporates capital intensity. The company that can derive more profits with less capital spending can more quickly strengthen its financial position. Dell has a generated an average of $3.5 billion in free cash flow in the past four years, equating to a free cash flow yield of more than 25%, which is truly stunning. HP has generated an average of $8.5 billion in free cash flow in each of the past four years, equating to a still impressive 15% free cash flow yield.
Result...
Dell: 8.5 points
HP: 6.5 points
Factor #4: Management track record and corporate governance
Weighting 10 points
HP gets an incomplete upgrade because it is under relatively new management. Dell, on the other hand, deserves a failing grade.
Michael Dell has made a series of bold moves, yet none have been able to move the needle. Even lumbering Microsoft (Nasdaq: MSFT) now appears to be making a series of winning moves, proving that you can't blame the tough external environment for Dell's underwhelming results. And the fact that Michael Dell runs the company with a seemingly free hand tells you that the company's board provides few checks and balances.
HP's management -- and board -- are fairly new, so an incomplete grade is justified. Still, the decision to shed thousands of employees and re-invest the savings into niches with higher growth opportunities is bold enough to merit attention. Compared to Dell's weak management and governance, HP's fresh slate of officers and directors get the nod.
Result...
Dell: 4 points
HP: 6 points
Factor #5: Industry positioning
Weighting 15 points
HP is the world's largest seller of PCs and laptops, which is nothing to brag about in a world increasingly dominated by tablet computers and smartphones. Nevertheless, this segment accounts for a smaller percentage of sales than it does for Dell. HP has lost its edge in the IT services market as companies like IBM (NYSE: IBM) take market share. Still, outsourced IT management is a trend that continues to grow, and HP remains a viable candidate when major contracts come up for bidding.
Dell has been pursuing a greater emphasis on enterprise hardware, especially with a string of data storage acquisitions. Yet even as Dell pursues best-of-breed niche vendors in this segment (and pays top dollar for them), the company is still seen as something of an also-ran when compared to storage-focused vendors such as EMC (NYSE: EMC). Frankly, neither of these companies have much to show for internal R&D efforts and have ended up overpaying for other companies. Improved R&D execution is essential for future relevance for these firms.
HP's service focus gives the company a slight edge.
Result...
Dell: 7 points
HP: 8 points
Factor #6: International exposure
Weighting 13 points
With Europe in trouble and China slowing down, the United States is suddenly looking like the place to be. Companies with a higher percentage of sales in the United States now look better-equipped to meet forward earnings estimates. HP derives 45% of sales in the U.S. (and 36% in Europe, Africa and the Middle East (EMEA)). In contrast, Dell derives 49% of sales in the U.S., while the EMEA region accounts for roughly 30%.
Result...
Dell: 7 points
HP: 6 points
Factor #7: EPS trends
Weighting 12 points
Earnings forecasts continue to trend in the same direction, so the recent downward revisions to Dell's EPS (earnings per share) forecasts are likely to continue. Stock prices often track earnings revisions and it's hard for a stock to rally while forecasts are still coming down. HP's earnings forecasts have remained largely unchanged and may even rise a bit, thanks to the recently announced huge layoffs that will take effect in the quarters ahead.
Result...
Dell: 5 points
HP: 7 points
Factor #8: Analyst opinion
Weighting 8 points
As analysts reiterate bullish or bearish opinions on a stock, they can have an impact on the stock price. HP's average analyst rating is 2.6 (with 1.0 being a strong "Buy"), while Dell's is 2.3.
Result...
Dell: 4.5 points
HP: 3.5 points
(This is arguably generous as Dell has seen a few downgrades since Yahoo last updated analyst ratings scores.)
Action to Take --> By a decent margin, HP looks like the better stock to own. The fact that HP trades for about five times projected 2013 profits while Dell trades for around six times tells you that both of these stocks are extremely inexpensive. Dell's solid balance sheet should provide support to shares at current levels, but HP looks better positioned to make the bold moves that can restore the company back into relevance -- and deliver profits to shareholders.
David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of MSFT in one or more if its “real money” portfolios.
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