Tuesday, June 19, 2012

HP Trades Below Book Value

The First Pacific Advisors 2011 Annual Report, notes Morningstar's Fund Spy, has a dicussion of its taking a position in HPQ.  It established a small position in the $40s when it believed that the P/E was 8. Further it believed that the printing business was an annuity (which is surprising) and that the services business would have adequate cash flows even in a down turn.  "Subsequent research revealed that neither business was as resilient as we thought," which is why even in the world of mega-cap investing with overfollowed companies, there is always value in doing research and questioning your own assumptions.  Once FPA had established a position, they allowed "rationalization" to creep into their process: in other words, it was difficult to accept that they had made a mistake, sell the stock and move on.  I have often fallen prey to this emotion, especially if I had put a lot of work in on the front end.

HP management, FPA writes, made a series of reckless decisions, including a multi-billion dilutive acquisitions, a publicly announced commitment to WebOS which was retracted within a month, and declaring their intent to selling the PC business without a buyer and without regard to the impact on prospects and customers.  This decision too was retracted, subsequent to the FPA report's being issued.

Their key conclusion is that Hewlett Packard is not Wang Laboratories, although its corporate evolution has quite a few eerie similarities.  The stock declined to $21.50, and FPA added to positions on the way down, and they said the stock bounced back to $25.76 at year end.

In today's trading, Forbes reports that the shares traded below their trailing four quarter book value.  The chart looks bad.  FPA's talking about their own investment process and how it went wrong is very instructive for readers like me and for their own shareholders in understanding their valuation and investment process. 

FPA was "wrong" on their investment thesis, but they acted as if their timing was wrong, and so they held on and added more.  This is what they mean by rationalization.  Are today's investors looking at a compelling valuation? 

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