Klaus Vedfelt/DigitalVision via Getty Images

Klaus Vedfelt/DigitalVision via Getty Images

The recent acquisition of an 11% stake of HP Inc. (NYSE:HPQ ) by Berkshire Hathaway (BRK.A) (BRK.B) should not be taken lightly, especially in the current circumstances. This was one of the largest monetary as well as percentage stake in a business that Buffett has made in recent years. Today, the share price lies exactly where Berkshire acquired its stake at - a great opportunity for believers in the shrewdness of the world's greatest investor. The fact also that the stake was announced on the 7th of April - 6 weeks after the start of the Ukraine war - means that Buffett and his associates were not put off by the economic consequences of the war and the spiralling inflation. Why?

There are times for exciting growth business, and there are times for boring old school businesses. In turbulent times, the boring old businesses always win. HP has been a traditional technology business for years, selling computers and printers to both retail and business consumers. In the first financial quarter, ending 31st of January 2022, the company reported that 72% of revenues came from Personal Systems - which are mainly notebooks and desktops. 28% came from printers and printing supplies. These are low moat sectors but HP managed over the years to create and maintain a leading position in 57 countries in print or PCs. This is no easy feat, especially given how easy and low technology it is to make computers and printing equipment.

HP has been able to achieve its success by acting as a hybrid between a technology company and a consumer goods company. It maintained a high level of investment in research and development - spending 2.5-3% of revenues on R&D, a total of USD 5 billion in the past three years. It has kept a tight lid on cost, generating gross profits margins between 18% and 20% in the past three years, and maintaining a tight grip on working capital management, helping it to generate strong operating cash flows. But the key competitive edge that HP has created has been the mammoth global supply chain and global distribution reach that it has created - allowing it to produce low cost products and deliver them efficiently and smoothly to mass consumers. HP operates in 90% of Earth - selling its products in 170 out of 193 countries on the planet. It has 250,000 channel partners facilitating the reach across different markets. And the billions the company spends on R&D have not be going to waste; the company has an eye-watering 27,000 patents. The company has been growing more innovative products, such as gaming equipment, in order to compensate for low growth, or declining, volumes of traditional computing and printing equipment.

The planned financial Q2 results on the 31st of May 2022 will provide investors with valuable insight on how business fared during the critical February-April period when hell broke loose economically around the world. It is a fair expectation that revenues and profit margins will almost certainly have declined versus Q2 of 2021. This would continue the trend of deflation of the COVID lockdown boom in homeworking that gave a boost to purchases of personal computing and printing equipment. But also the combo hit in Q2 of the Ukraine war, the China lockdowns and the inflation spiral will all certainly have a direct hit on business.

All these negative factors are being priced in by investors, which resulted in the decline of the share price by 17% in the past five weeks, and in the current low-ball valuation of 6.4 times P/E and 5.9 times market cap to operating cash flow. Dell's larger business is trading at almost the exact same P/E of 6.5 times, although with cheaper market cap to operating cash flow of 3x.

Aggressive shareholder returns strengthen the valuation metrics. USD 7 billion have been paid out in 2021 on share buybacks and dividends - a whopping 20% of market cap. This is one of the main reasons Berkshire Hathaway would have acquired its stake, as Warren Buffett has always been a strong supporter of share buybacks to boost investor returns.

An aggressive assumption of halving the profitability levels at HP would still make the shares look cheap at today's price, giving today's investors, including Warren Buffett, a good buffer.

This article was written by

Disclosure: I/we have a beneficial long position in the shares of HPQ either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.