Insider Trading Report: Hewlett-Packard $HPQ

Since the start of 2012, the technology sector has been the best performing segment of the market, returning nearly 11 percent.  Much of this expansion has been driven by the computer systems industry, which has grown twice as quickly.  Interestingly, one of the largest companies in this arena has also been quite the laggard.  Hewlett-Packard (NYSE: HPQ) has lost 15.8 percent year to date.  In its most recent earnings release, the company reported revenues and EPS figures that were lower than one year earlier.  Much of HPQ’s troubles have been blamed on its failure to innovate itself into the cloud computing craze, which is taking the industry by storm.

Hewlett-Packard Company (NYSE:HPQ)

Despite these difficulties, the company has seen a rash of insider purchasing activity over the past month, which begs the question: does the tech behemoth have something big up its sleeve?  Or perhaps execs just believe they are better positioned for the long haul than competitors like Dell (NASDAQ: DELL) and Cisco Systems (NASDAQ: CSCO), who have reported similar earnings shortcomings.  Either way, insider buys are an important indicator for investors to follow, as empirical studies have proven that those who mimic or ‘monkey’ this behavior can beat the market by up to 7 percent a year (read here to learn more about the insider trading anomaly).  Below are the accounts of two HPQ insiders that have been buying furiously since May.

J. Raymond Lane: A power player in the tech world, Raymond Lane was one of the most important men at Oracle before leaving in the height of the tech boom, albeit with a boatload of cash.  Since then, Lane has pursued his own private equity firm, served as a board member at Quest Software, and headed Hewlett-Packard’s board since late September of last year.  In his time as Chairman, he has exercised none of his $8.5 million worth of stock options, instead choosing to take a larger position in HPQ.  Notably, all of these purchases have occurred since May 31st, in which Lane has bought 226,300 shares worth nearly $4.5 million.  Since his purchase, shares of HPQ have wilted by almost 5 percent, though the bullish retort from insider buying typically takes between 6 and 12 months.

V. Ralph Whitworth
: Another board member that joined Hewlett-Packard in late 2011, Ralph Whitworth is a founder of Relational Investors LLC, a renowned private investment management firm.  Whitworth’s firm holds 38.2 million shares of HPQ, at a total market value north of $825 million.  In recent years, Whitworth has also served as a Director at Guaranty Bancorp and Genzyme Corp, and has garnered quite the reputation as an activist shareholder.  Upon his induction into Hewlett-Packard’s board, he promised to stimulate shareholder value through dividend boosts, share buybacks, and a stronger commitment to research and development.  Between May 25th and June 1st of this year, Whitworth bought 18.2 million shares of HPQ, at prices between $21 and $22 a share.  It is notable that most of these purchases occurred just two days after the company’s disappointing second quarter earnings release.

As mentioned above, Hewlett-Packard reported revenues and earnings that were below figures from Q2 of 2011.  Most troublingly, EPS fell from $1.24 a share to $0.98 a share, though this was above analyst estimates of $0.91 a share.  In step with this release, the company reported that it was laying off 27,000 of its employees, which amounts to 8 percent of its workforce.  It is estimated that these layoffs will save the company between $3 billion and $4 billion over the next year, most of which will be reinvested in R&D.

Interestingly, the company announced this week that it has already taken steps to become more competitive in the commercial cloud computing market.  Officially called the HP Converged Cloud Services for Airlines, their new service will allow airliners to combine inventory and reservation systems into one integrated network, in the hope that efficiency gains and cost savings can be achieved.  Additionally, the company is pushing to be the sole provider of cloud-based storage services to airliners.  While it remains to be seen if this move will prove to be a gamechanger, it is a step in the right direction for Hewlett-Packard.

From a valuation standpoint, shares of HPQ are an enigma.  The stock sports a Price-to-Earnings ratio (8.4X) below the industry average (13.1X), and peers like Cisco at 12.4X and IBM (NYSE: IBM) at 14.5X, though Dell at 6.7X and Lexmark International (NYSE: LXK) at 6.4X look more attractive. When earnings growth is factored into the equation, HPQ sports a PEG of 0.8, though this is again above that of Xerox and Lexmark.

Historically speaking, Hewlett-Packard’s earnings have traded at a 30 percent discount relative to those of the S&P 500 over the past decade.  This year, they are slightly cheaper; trading at a 40 percent discount.  The company’s EPS shrinkage, though, may warrant this decline in value, so investors should tread carefully.  If the year-ahead consensus earnings forecasts of $4.06 – and that’s a big if – is accurate shares of HPQ can eclipse $30 a share.  Going forward, bulls also have the insider trading anomaly and the activist tendencies of Ralph Whitworth on their side, so this price target on HPQ may be attainable by the summer of 2013. Deep value investor Seth Klarman’s $400 million position in the stock is also comforting.