Investors who like to cast their lot with the darlings of the market will probably never like to own Lenovo (OTCBB:LNVGY). Although this Chinese PC, smartphone and IT hardware company has ample growth potential in both emerging and developed economies, the company's low margins and volatile results keep many people at bay. Although Lenovo is not going to be a good stock for those who worry a lot about volatility, there seems to be quite a lot of value in these shares.

Discount Brokers Comparison: Your one-stop shop for finding the perfect broker for your investments.

Continuing to Grow Through a Tough Market
These are not easy times in the global PC market, nor in individual markets like China or the United States, but Lenovo continues to substantially outgrow these markets.

Revenue rose 35% in the June quarter, while operating profit grew 46%. Although Lenovo did produce some operating margin expansion from last year's June quarter, the absolute level of margins (2.3% in the June quarter) is still exceptionally low compared to American peers like Hewlett-Packard (NYSE:HPQ), Dell (Nasdaq:DELL) and Apple (Nasdaq:AAPL).

SEE: A Primer On Investing In The Tech Industry

Building Strength on Strength
Lenovo was already the No. 1 PC company in China and the No. 2 supplier in the world, and the company is quickly closing the gap on HP. While the global PC market shrank about 1% in the June quarter (in terms of shipments), Lenovo's shipments grew 24%. While the company is very unlikely to match its 35% in China in the U.S., its strong position in the business PC category continues to grow.

And the company clearly isn't done yet. Lenovo has big share in China (about 35%), India (17%) and Russia (12%), but not much in Brazil (sub 4%). Now the company is doing something about that - buying CCE, the sixth largest PC vendor in Brazil, in a move that will make it the No. 3 overall player. There had been rumors that Lenovo would go for the much larger Positivo, but the CCE buy makes me think the company believes it can still garner a lot of long-term organic growth in Brazil.

Not Just About PCs
I believe that analysts and investors too often underestimate Lenovo's growth potential outside of its PC business. This flies in the face of Lenovo's declared "Protect and Attack" strategy - protect cash-rich markets like the Chinese and U.S. business PC markets, while aggressively expanding into markets like servers and smartphones.

On the smartphone front, so far so good. Lenovo has quickly built itself into the No. 2 smartphone company in China, with about 12% share. Samsung still heads the list at 20% share, but I wouldn't underestimate the company's ability to further take share from Nokia (NYSE:NOK) in the emerging markets and, perhaps, seriously enter the U.S. market at some point. To that end, it wouldn't be entirely out of character for Lenovo to consider buying Research In Motion (Nasdaq:RIMM), provided it still sees some value in that brand name.

Lenovo also recently announced a new joint venture (JV) with American storage giant EMC (NYSE:EMC). The two companies will get together to develop server products, while Lenovo will also distribute EMC products in China. This will be an interesting deal to watch. Neither company is strong in servers, but I wouldn't count out Lenovo just yet. At a minimum, this should be a good deal for EMC, as the company has a long history of ill-fated JVs in China, and the company's sales into the Chinese market are lower than they probably ought to be.

The Bottom Line
Although Lenovo generates very low operating margins and low free cash flow margins that needs to be set next to the fact that Lenovo still generates double-digit returns on capital, and seems to have found a defensible niche in profitably manufacturing mature IT hardware like PCs and notebooks. What's more, the company is still flush with cash, giving it multiple options in terms of acquisitions and product development investment.

SEE: 5 Must-Have Metrics For Value Investors

How undervalued does Lenovo appear to be? Projecting just 2% free cash flow compound growth over the next decade is sufficient to fuel a target price well into the $20s, even with an above-average discount rate. Although I don't think Lenovo is going to get much attention until investors feel better about the health of China's economy, I believe this is an undervalued way to play ongoing IT hardware demand growth in multiple emerging markets.

Stephen D. Simpson owns shares of EMC since September 2012.

Related Articles
  1. Stock Analysis

    Starbucks: Profiting One Cup at a Time (SBUX)

    Starbucks is everywhere. But is it a worthwhile business? Ask the shareholders who've made it one of the world's most successful companies.
  2. Stock Analysis

    How Medtronic Makes Money (MDT)

    Here's the story of an American medical device firm that covers almost every segment in medicine and recently moved to Ireland to pay less in taxes.
  3. Investing News

    Latest Labor Numbers: Good News for the Market?

    Some economic numbers are indicating that the labor market is outperforming the stock market. Should investors be bullish?
  4. Investing News

    Stocks with Big Dividend Yields: 'It's a Trap!'

    Should you seek high yielding-dividend stocks in the current investment environment?
  5. Investing News

    Should You Be Betting with Buffett Right Now?

    Following Warren Buffett's stock picks has historically been a good strategy. Is considering his biggest holdings in 2016 a good idea?
  6. Products and Investments

    Cash vs. Stocks: How to Decide Which is Best

    Is it better to keep your money in cash or is a down market a good time to buy stocks at a lower cost?
  7. Investing News

    Who Does Cheap Oil Benefit? See This Stock (DG)

    Cheap oil won't benefit most companies, but this retailer might buck that trend.
  8. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  9. Stock Analysis

    Performance Review: Emerging Markets Equities in 2015

    Find out why emerging markets struggled in 2015 and why a half-decade long trend of poor returns is proving optimistic growth investors wrong.
  10. Investing News

    The UAE: An Emerging Economy for Investors

    The learning from UAE on how it succeeded with timely diversification when the BRICS nations and the neighboring oil-rich economies faced challenges.
RELATED FAQS
  1. When does a growth stock turn into a value opportunity?

    A growth stock turns into a value opportunity when it trades at a reasonable multiple of the company's earnings per share ... Read Full Answer >>
  2. What is the formula for calculating EBITDA?

    When analyzing financial fitness, corporate accountants and investors alike closely examine a company's financial statements ... Read Full Answer >>
  3. How do I calculate the P/E ratio of a company?

    The price-earnings ratio (P/E ratio) is a valuation measure that compares the level of stock prices to the level of corporate ... Read Full Answer >>
  4. How do you calculate return on equity (ROE)?

    Return on equity (ROE) is a ratio that provides investors insight into how efficiently a company (or more specifically, its ... Read Full Answer >>
  5. How do you calculate working capital?

    Working capital represents the difference between a firm’s current assets and current liabilities. The challenge can be determining ... Read Full Answer >>
  6. What is the formula for calculating the current ratio?

    The current ratio is a financial ratio that investors and analysts use to examine the liquidity of a company and its ability ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center