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Timidity Tempers Hewlett-Packard Rally

A huge top-line beat can't offset recent volatility.

SAN FRANCISCO -- With its massive beat Thursday,

Hewlett-Packard

(HPQ) - Get HP Inc. (HPQ) Report

made another convincing showing that it's more than a mere cost-cutting story.

The company surpassed Wall Street revenue

estimates by a whopping $1.4 billion, notching its strongest growth since the boom days of 2000.

CEO Mark Hurd said the company was poised to collect even more of the world's spending on information technology, which he said would reach $1.1 trillion by 2009.

"We've got a lot more market to get after," said Hurd.

But the call to arms and the giant upside elicited a more tempered reaction on the Street, where, despite Friday's rally, fear and uncertainty about the economy and the capital markets continue to linger.

H-P's stock was up just 2.4%, or $1.10, to $47.15 in recent trading Friday.

Analysts noted that H-P's strong quarter was already priced into the stock. And while H-P has benefited from its presence in the world's fast-growing markets, the company also has a good deal of exposure to sectors that could be at risk of weakening.

Financial services companies -- big buyers of technology -- look increasingly shaky as their investments in mortgage-backed securities blow up.

More worrisome for H-P is the potential of a consumer slowdown.

"I'm bullish on H-P as a company," says David Schamens, of Invictus Funds. "Unfortunately, the macro environment as a whole is probably not going to favor H-P's stock."

With the housing market losing steam and consumers stepping back from home-equity loan-financed shopping sprees, Schamens believes the economy is due for a recession by the middle of next year.

While Schamens has no position in H-P, he says his firm is heavily short the consumer in general.

On the PC side of the business, H-P acknowledged Thursday that sales are slowing. As a result, H-P said it expects that revenue in the current quarter will grow slower than normal for this time of year.

But the company framed the PC slowdown as more of a natural cooling-off after several quarters of outsize sales growth, rather than an indication of weakening demand.

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During the quarter, H-P grew its notebook revenue 54% and increased its sales of corporate PCs by 19% year over year, putting more pressure on rival

Dell

(DELL) - Get Dell Technologies Inc Class C Report

.

"They can't grow three times the market forever," says T. Rowe Price hardware analyst Chirag Vasavada, which has a position in H-P. "If they do, they'll become the market."

While Vasavada is mindful of H-P's exposure, he believes the stock will fare well in the long run so long as the company maintains the solid business execution that it has displayed.

And he notes there's even a case to be made that H-P's stock has some of the defensive qualities that investors look for in a down economy.

Given that PCs are increasingly becoming a nondiscretionary item for segments of the population such as students, H-P's lineup of low-cost machines could do well in a downturn, taking sales from companies that make high-end consumer PCs.

H-P's printer ink business, the company's most profitable group, could also see sales hold up even as consumers cut back on spending.

H-P may not be as defensive as downturn stalwarts such as

Kraft Foods

(KFT)

, says Vasavada, but the stock stands out within the technology sector.

Analysts reacted to H-P's strong fiscal third quarter by raising their estimates Friday.

While some analysts took note of the 10% sequential growth in H-P's inventory level, few seemed overly concerned by it.

"Like last year, H-P's inventory build is a direct result of upcoming seasonal demand," Goldman Sachs analyst Laura Conigliaro wrote in a note to investors.

Goldman Sachs makes a market in shares of H-P and has received compensation from H-P for investment banking and non-investment banking in the past 12 months.

And while H-P benefited from cheap component costs during the quarter, Conigliaro said that H-P's profit margin trends are favorable notwithstanding the low costs, pointing to big improvements in groups such as software and services, where component costs are not an issue.

"We think bears are missing the point," Conigliaro said.