Hewlett-Packard (NYSE: HPQ ) announced its fourth-quarter earnings after the
close of business Nov. 21, and as everyone knows by now, they were awful. To her
credit, CEO Meg Whitman didnt try to paint a pretty picture, preferring instead
to be brutally honest about the difficulties that lie ahead. With HP trading 53%
below its five-year high, value investors are likely taking a close look at the
battered tech giant. Its an intriguing proposition for sure. That said, unless
youre prepared for several years of volatility, the smarter bet is to pass on
Hewlett-Packard and buy IBM (NYSE: IBM ) instead. The natural thing for
investors to focus on in HPs fourth-quarter earnings is the $885 million
impairment charge to goodwill and purchased intangible assets resulting from the
shuttering of its WebOS tablet and smartphone business. That charge cut
operating profits for the year by 8.4%. Its a big chunk for sure, but so much
more is going wrong at HP that its pointless to worry about the impairment
charge. Add back in the $885 million, and you still have an 8% decline
year-over-year in operating profits on a 1% increase in revenues. Operating
margin narrowed 80 basis points to 8.3%, its lowest rate since 2006. Now compare
this effort with IBM. In the nine months ended Sept. 30, IBMs operating margin
was 18.1%, 80 basis points better than the same period a year earlier and nearly
double HPs. Its hard to find anything that paints a clearer picture of the
differences between the two companies. 5 Reasons to Shun HP Larry Dignan,
editor-in-chief of ZDNet, wrote today about five specific areas of concern for
HP in 2012. At the top of the list is HPs enterprise servers, storage and
networking unit. Dignan points out that the group saw a 4% decline in revenue in
the quarter. What he doesnt mention is that the units operating income dropped
17.5% year-over-year to $733 million. While thats still 20% of HPs overall
operating profit in the quarter, the slide is definitely troubling. HPs biggest
revenue loser in the quarter was its Itanium-based server line, which saw
revenues decline 23% due to a lawsuit with Oracle (NASDAQ: ORCL ) that contends
HP is forcing Intel (NASDAQ: INTC ) to continue developing the Itanium servers
despite the fact they arent selling. Its not a good partnership when one party
is forced to participate. Services, the segment upon which IBM rebuilt itself a
decade ago, seems to be failing HP. In the latest year, this segments operating
profit declined 160 basis points to 14.3%. Dignan points out that this measure
has been on a downward slide since the fourth quarter of 2010. On the other
hand, IBMs operating margin for services in the first nine months of the year
increased 90 basis points year-over-year to 14%. Perception is everything I
suppose. Having recently written an article about Lexmark (NYSE: LXK ), Im all
too aware that consumers are cutting back on the use of printers and ink. In
2011, HPs printing and imaging group saw operating margins decline by 400 basis
points to 13.1%. Basically, it was giving away the ink. Last, and the most
important of the five points, is research and development. HP has gotten away
from R&D spending in recent years, and it shows. No longer, says Whitman, will
HP avoid innovation. That cant happen soon enough. HP currently spends 2.5% of
overall revenue on R&D compared to 6% for IBM. Unfortunately, Whitman suggests
the increased spending wont arrive until 2014 at the earliest. If thats true,
why would any investor gamble on something hypothetical when you can get the
real thing at IBM. Warrens Big Blue Wisdom Warren Buffett is known to invest in
great companies. IBM was a great company for a long time, before stumbling in
the early 1990s. Lou Gerstner took over in 1993 and completely changed the
culture and in the process reinvigorated Big Blue. He then wisely passed the
baton to Sam Palmisano, who himself will hand the top job to longtime IBM
veteran Virginia Rometty on Jan. 1. Seamless transitions. Something HP can only
dream about. Buffett recently became the largest IBM shareholder because he saw
a company that avoids the drama of business and simply makes money. By 2015, it
should earn $20 a share. In 2001, IBMs EPS was $4.35 with an average market
price of $104 for a P/E of 24 times. Its EPS in 2011 will be more than $13 for a
P/E of 14 times. Id say Buffett paid a fair price for a great company. Forget
the value play in HP and invest in the better company. As of this writing, Will
Ashworth did not own position in any of the stocks named here.
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