Dear Valued Visitor,

We have noticed that you are using an ad blocker software.

Although advertisements on the web pages may degrade your experience, our business certainly depends on them and we can only keep providing you high-quality research based articles as long as we can display ads on our pages.

To view this article, you can disable your ad blocker and refresh this page or simply login.

We only allow registered users to use ad blockers. You can sign up for free by clicking here or you can login if you are already a member.

Hewlett-Packard Company (HPQ)’s Strong Q2 Showcases the Growing Irrelevance of PCs

Associated Press coverage of Hewlett-Packard Company (NYSE:HPQ)‘s quarterly earnings report on Wednesday opened with this statement: “Hewlett-Packard’s slump is deepening as the world’s largest personal computer maker scrambles to meet the growing demand for more versatile and less expensive mobile devices.”

The AP’s coverage of the earnings report buried the fact that HP actually beat earnings expectations and raised its outlook for the current fiscal year. Moreover, while it’s factually accurate that Hewlett-Packard Company (NYSE:HPQ) is the world’s largest personal-computer maker, PCs are actually a minor component of HP’s overall business from a profit perspective.

Based on HP’s strong stock performance on Thursday — shares rose 17% to close at $24.86, after hitting a new 52-week high of $24.95 — investors are starting to see past the weak PC business. As I have previously written, while the PC group is the largest HP business segment by revenue, it is no longer a major profit driver for the company. Instead, investors should value Hewlett-Packard Company (NYSE:HPQ) based on its opportunities in other business segments, such as printing and enterprise IT.

PC decline is overblown
After IDC reported last month that HP’s PC unit shipments had declined 23.7% in Q1, a flurry of concern about HP’s PC business (re)surfaced. Many investors worried that Hewlett-Packard Company (NYSE:HPQ)was bearing the brunt of the PC market’s weakness. Last week, key competitor Dell Inc. (NASDAQ:DELL) reported a decline in PC sales and massive margin erosion for last quarter, which further heightened concerns about HP’s PC results.

However, while HP saw a larger decline in PC revenues than Dell last quarter, it was because the two companies adopted opposite strategies. Dell Inc. (NASDAQ:DELL) chose to cut prices in an attempt to gain market share. As a result, its “End User Computing” division’s operating margin dropped from 6.5% to 2.5%.

Hewlett-Packard CompanyMeanwhile, Hewlett-Packard Company (NYSE:HPQ) decided to prioritize profitability over market share. PC segment operating margin fell more modestly year over year, from 5.4% to 3.2%. That drop led to a 54% decline in the division’s operating income, compared with 2012. That said, PC operating income actually improved by $16 million compared with the previous quarter.

In short, HP’s apparently disastrous PC results were actually the result of a conscious decision to pursue profitability rather than market share in the PC business. Since the PC market will continue to decline over time, emphasizing profitability over market share seems like a very good strategy.

Profit comes from elsewhere
Investors also need to put the PC business in perspective compared with HP as a whole. The segment’s operating income of $239 million last quarter represented less than 10% of total segment operating income across the company (which excludes unallocated costs). Since the PC business involves minimal fixed costs, Hewlett-Packard Company (NYSE:HPQ) should be able to manage future PC revenue declines without bleeding red ink. For example, PC segment profitability increased sequentially last quarter in spite of an 8% revenue decline.

By contrast, the printing division produced operating income of $958 million last quarter: quadruple that of the PC group. The printer business has rebounded strongly this year because of HP’s industry-leading position and new initiatives to improve sales and profitability.

Looking forward, the yen’s depreciation will lead to lower costs for Hewlett-Packard Company (NYSE:HPQ)’s laser printers in the second half of 2013, because HP sources many components from Canon Inc. (ADR) (NYSE:CAJ) in Japan. This may be offset somewhat by stronger price competition from Japanese printer manufacturers such as Brother and Canon, but the net effect will probably be positive for HP.

Foolish bottom line
HP’s turnaround is not yet complete, but it is starting to make visible progress in areas such as printing. Moreover, the company trades for less than seven times projected earnings for the current year. Investors need to recognize HP’s PC business for what it is: a small (though highly visible) component of HP.

With the PC group already providing a very modest contribution to HP’s overall profitability, any future declines there could be easily offset by the company’s ongoing cost cuts and/or recovery of other business lines. While CEO Meg Whitman has repeatedly stressed that it will take a few years for this recovery to take hold, HP still seems like a bargain at its current valuation.

The article HP’s Strong Q2 Showcases the Growing Irrelevance of PCs originally appeared on

Fool contributor Adam Levine-Weinberg owns shares of Hewlett-Packard. The Motley Fool has no position in any of the stocks mentioned.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

DOWNLOAD FREE REPORT: Warren Buffett's Best Stock Picks

Let Warren Buffett, George Soros, Steve Cohen, and Daniel Loeb WORK FOR YOU.

If you want to beat the low cost index funds by 19 percentage points per year, look no further than our monthly newsletter.In this free report you can find an in-depth analysis of the performance of Warren Buffett's entire historical stock picks. We uncovered Warren Buffett's Best Stock Picks and a way to for Buffett to improve his returns by more than 4 percentage points per year.

Bonus Biotech Stock Pick: You can also find a detailed bonus biotech stock pick that we expect to return more than 50% within 12 months.
Subscribe me to Insider Monkey's Free Daily Newsletter
This is a FREE report from Insider Monkey. Credit Card is NOT required.