Is 2010 the “Year of the Hard Disk Drives?”

By Travis Johnson, Stock Gumshoe, April 15, 2010

I was reading earlier today about Porter Stansberry’s aggressive short bet against the computer hard drive makers, who seem to have been the canaries in the coal mine regarding computer sales for several years — and at the same time I received a teaser from Louis Navellier for his Blue Chip Growth teasing that the big pop in shares of his favorite hard drive company is “just the beginning.”

So I thought, let’s let them slug it out virtual-style, and you can decide for yourself whether it’s better to go long or short the hard drive makers … and, as soon as I sniff out which one of them is Louis’ favorite, we can see if that’s the one you’d buy (or sell) as well.

First, Porter’s opinion. It was excerpted in his Daily Crux today under the “two stocks to sell immediately” headline, and apparently Seagate and Western Digital, the two dominant pure-play companies in this space, are his favorite short sales as recommended in his Investment Advisory newsletter back in February. According to the excerpt, he believes their product is slowly becoming obsolete thanks largely to flash memory improvements, and that new demand is coming primarily from the corporate segment, which is bad (I assume because of lower margins or the product mix of these companies, don’t know). He also quotes an analyst as noting the likelihood of margin squeezes as their biggest customers, HP and Dell, try to reduce costs.

So that’s the big picture — hard drives are becoming obsolete and less profitable, according to Porter and the analyst he quotes.

But what about Louis Navellier? It’s been my experience that a climbing share price, improving margins, and increased analyst estimates make him love a stock, and both of these companies have been in that position during their recent turnarouind. So which is his favorite?

Here’s the tease:

“I don’t know about you, but when it comes to the inner workings of my computer, I’m at a loss. But one thing I do know is that hard drives are vitally important—they store all of our data and programs.

“So when you have a company that produces hard drives for a wide range of tech gadgets—personal computers, consumer electronics, high-end servers and mainframes—to some of the biggest computer manufacturers in the world (Dell, Hewlett-Packard, EMC, IBM and Sun Microsystems), I definitely take notice.

“This company is truly a global leader, with 75% of its sales to manufacturers outside of the U.S. And thanks to the strong demand for its products, the company was able to post a 33% increase in sales in the fourth quarter—an outstanding performance in a recession.

“But here’s the really incredible news—after posting a $2.8 billion earnings loss in the fourth quarter of 2008, the company bounced back, with earnings surging to $533 million! Now, that’s a strong turnaround.

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“Looking forward, 2010 is expected to be the ‘year of the hard disk drives,’ according to a Wedbush Morgan analyst. This company’s shares already popped nearly 20% in February on the strength of this industry—and this is just the beginning.”

And the envelope, please? This one is clearly Seagate Technology (STX)

Seagate undoubtedly got the attention of Navellier’s system thanks to a huge “beat” on the fourth quarter earnings, fourth quarter sales did indeed “surge” 33% and earnings came in at $1.04, which is more than 50% above the analyst estimate. And he’s been publicly touting the shares as a recent favorite as well, not just teasing them in his email ads.

It’s pretty clear that Porter Stansberry is not the only one who is feeling extra cautious about the hard drive business, though — otherwise, there’s no way we’d see a stock with that kind of earnings growth trading at a bargain basement forward PE ratio of 5 (Western Digital’s is super low as well, right around 7).

In fact, if you ignore the fundamentals of the business they’re in and just look at the analyst projections, you’d be an idiot not to buy Seagate — analysts think they’ll grow 11% a year for five years, they’re very profitable, they have no net debt, and they trade at 5X earnings. That’s a ridiculous bargain — but of course, we should never put too much weight on what an analyst thinks the five year growth rate will be, since they’re just making it up (sorry to all my economist friends, I meant to say “forecasting”).

Western Digital and Seagate are certainly tough competitors, but it’s also worth looking at the charts from their last few turbulent years — Seagate has done far better over the past year, but that’s largely because they fell much harder when the economy swooned and therefore had the room to enjoy a much higher bounce off the bottom, over the last five years WDC has been a much better performer for your portfolio. For what it’s worth, though analysts have been opining on both sides of this, the Wedbush Morgan analyst (presumably the same one who declared that “year of the hard drive”) also recently downgraded Seagate in part because they might lose some market share to WDC (that’s the same analyst that Porter quoted in the Daily Crux above, just FYI).

So in this case it really comes down to predicting the future — do you believe the growth on the ground, and think their spectacular performance will continue? Or do you fear the future and think these stocks will either eat themselves with margin-crushing competition, or lose out on their buggy whip business to the hot new iron horses coming out of the assembly line? Let us know which way you lean with a comment below.

And of course, if you’ve ever been a subscriber to either Porter Stansberry’s Investment Advisory or Louis Navellier’s Blue Chip Growth, click on either of those titles to review them for us over at Stock Gumshoe Reviews — we’ve heard from dozens of subscribers to both letters, but we want to know what you think!


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hwai
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hwai

I have bet on STX based on Louis's reco and my old memory tells me STX is better. I could be wrong with WDC so I will look at it more and decide which one to go for.

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Once in a while, people more or less have the tendency to take the eccentric, or even extreme, attitude in looking at this world. When Radio was first invented, some frontier people claimed the days of the newspaper were numbered. Decades later after that there were claims of the death of the radio when the TV was born. The last death prediction I heard was around1990 when Motorola was making so much money in selling its brick-size & brick-weight wireless phone that the company was crazy enough to try to launch 100 something satellites to the space in order to… Read More »

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