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. Investing

    Redefining the Stop-Loss

    Using Stop-losses for trading doesn’t mean ‘losing money’, but instead think about the money you'll start saving once you learn how they work.
  2. Fundamental Analysis

    10 Major Companies Tied to the Apple Supply Chain

    Apple has one of the best supply-chain models. Here are some of the top businesses involved, and the benefits and challenges for all.
  3. Term

    What are Non-GAAP Earnings?

    Non-GAAP earnings are a company’s earnings that are not reported according to Generally Accepted Accounting Principles.
  4. Mutual Funds & ETFs

    ETF Analysis: PowerShares FTSE RAFI US 1000

    Find out about the PowerShares FTSE RAFI U.S. 1000 ETF, and explore detailed analysis of the fund that invests in undervalued stocks.
  5. Options & Futures

    Use Options to Hedge Against Iron Ore Downslide

    Using iron ore options is a way to take advantage of a current downslide in iron ore prices, whether for producers or traders.
  6. Stock Analysis

    Fortinet: A Great Play on Cybersecurity

    Discover how a healthy product mix, large-business deal growth and the boom of the cybersecurity industry are all driving Fortinet profits.
  7. Stock Analysis

    2 Catalysts Driving Intrexon to All-Time Highs

    Examine some of the main reasons for Intrexon stock tripling in price between 2014 and 2015, and consider the company's future prospects.
  8. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  9. Charts & Patterns

    Understand How Square Works before the IPO

    Square is reported to have filed for an IPO. For interested investors wondering how the company makes money, Investopedia takes a look at its business.
  10. Markets

    Why Gluten Free Is Now Big Business

    Is it essential to preserving your health, or just another diet fad? Either way, gluten-free foods have become big business.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Profit Margin

    A category of ratios measuring profitability calculated as net ...
  3. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis ...
  4. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...
  5. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing ...
  6. Net Present Value - NPV

    The difference between the present values of cash inflows and ...
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  3. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  4. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
  5. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  6. What is the difference between the return on total assets and an interest rate?

    Return on total assets (ROTA) represents one of the profitability metrics. It is calculated by taking a company's earnings ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!