I’m sorry, but I don’t get the rally in Hewlett-Packard Company (NYSE:HPQ) shares. In just the last month, shares are up more than 35% because of “better than expected results.” Let’s get this straight, the company comes out and says it’s going to do terrible, but when they do less terrible than they thought, the stock is suddenly worth 35% more? I’m not buying this rally and there are four numbers that say investors should take profits now.
You Either Spend In This Area, Or You Get Left Behind
There is one category of spending that separates the industry leaders from the pretenders in the technology sector. Companies that spend on research and development have a much higher probability of success than those that don’t. If you want proof of this, look at a comparison of the R&D spending at the leaders Cisco Systems, Inc. (NASDAQ:CSCO) and EMC Corporation (NYSE:EMC) and the pretenders Hewlett-Packard Company (NYSE:HPQ) and Dell, Inc. (NASDAQ:DELL).
In the networking and storage industries, Cisco and EMC dominate their competition. Both companies are able to maintain their dominance because they spend money on R&D. In fact, Cisco spent 12% of their sales on R&D in the current quarter, while EMC spent 10.99% of their sales. By comparison, Hewlett-Packard and Dell spent 2.8% and 2.14% of their sales on R&D respectively. It’s no surprise that these two companies have fallen on hard times recently. In the technology field, if you don’t invest in future growth, you can’t compete.
Low R&D Spending = Lower Margins
A direct result of spending less on R&D is lower margins. If a company invents a unique product they should be able charge a higher price. Companies that play the “me too” game, and just create similar products, have to compete on price.
Many technology companies are increasing their focus on the enterprise space, as growth has been better in this sector. Dell has been pushing to grow in the enterprise business, but their operating margin of just 5.29% is the lowest of their peers. The company’s lack of R&D spending could be a key reason. Hewlett-Packard Company (NYSE:HPQ) is only doing slightly better with an operating margin of 7.9%, which was down from 8.6% last year.
Looking just at Hewlett-Packard’s enterprise business, their operating margin in this division was 15.5% in the last three months. By comparison, the enterprise focused Cisco Systems, Inc. (NASDAQ:CSCO) and EMC reported operating margins of 23.05% and 21.04% respectively. I have to believe it’s Cisco and EMC’s heavy R&D spending, that leads to the pricing power their margins suggest.
Lower Margins Can Also Come From Too Much Inventory
There aren’t many industries where too much inventory isn’t a big deal. When a company has relatively more inventory than their peers, investors should worry.