Should You Buy What Hewlett-Packard Company (HPQ)’s Selling?

Not surprisingly, Hewlett-Packard Company (NYSE:HPQ) CEO Meg Whitman sprinkled the recently announced Q2 earnings report with a host of niceties. Statements including, “we beat the upper end of our non-GAAP diluted EPS outlook,” and “we improved our operating company  net debt position for the fifth successive quarter,” aren’t a big deal; a little CEO-speak is expected in an earnings release. Thing is, HP’s 17% jump in share price since earnings were announced is largely based on beating its own forecasts. Even more concerning is the way HP “exceeded” expectations.

A few specs
As Hewlett-Packard Company (NYSE:HPQ) was quick to point out, nearly all areas of the business were down but beat earlier guidance. Second quarter’s non-GAAP (excluding one-time items) earnings were $0.87 a share, down 11% compared to Q2 of last year, but up from earlier guidance of $0.80 to $0.82. HP’s Q2 revenue was $27.6 billion, a drop of 10% from 2012, and non-GAAP operating margins also took a hit, though a minor one, decreasing to 8.6% in Q2 from 2012’s 8.9%.

The bright spots, in addition to Whitman confirming Hewlett-Packard Company (NYSE:HPQ)’s guidance for Q3 above analyst expectations, were cash flow from operations and an increased dividend. Cash flow from operations jumped a whopping 44% to $3.6 billion in the second quarter, up from $2.5 billion in 2012. HP’s strong cash flow allowed it to improve an already strong balance sheet, and it’s now sitting on $13.2 billion in cash and equivalents, up nearly $2 billion from two quarters ago.

A sound balance sheet and strong cash flows allowed HP to up its quarterly dividend to $0.1452 a share, a 10% bump from last quarter. At 2.49%, Hewlett-Packard Company (NYSE:HPQ)’s new dividend yield isn’t exactly setting the world on fire, but is right in line with others in the industry. Microsoft Corporation (NASDAQ:MSFT) and Dell Inc. (NASDAQ:DELL) pay shareholders 2.66% and 2.39%, respectively. International Business Machines Corp. (NYSE:IBM), another HP competitor attempting to transition beyond PC-related services and old-school IT hardware to burgeoning markets like enterprise services and cloud computing, pays a 1.84% dividend to it shareholders.

How’d HP do that?
The combination of a drop in most every business segment, a dying PC market, and its slow transition to new revenue sources, begs the question: “How’d Hewlett-Packard Company (NYSE:HPQ) beat expectations?” By aggressively cutting expenses, including Whitman’s planned 29,000 job reduction initiative by the end of next year and trimming costs across its business segments. The cost cuts are the right moves, and Whitman has been largely applauded for her efforts.

But here’s the thing; beating expectations based almost entirely on expense reductions, as positive as those steps have been and will continue to be, doesn’t bode well for investors in either the near or mid-term. Why? Whitman put it best on Hewlett-Packard Company (NYSE:HPQ)’s conference call, saying, “We need to do a better job growing the top line.” She got that right, too.