While our dependency on technology and instant access to information continues to grow, our methods for accessing and storing that information are constantly evolving and advancing. While many will seek added storage capacity in the cloud, there will continue to be large demand for data storage inside our ever smaller devices. Investors today have the opportunity to take advantage of this trend and profit for years to come by selecting the right investments and avoiding the wrong ones now.
Great for the past year but bad for the future?
Famous short-seller Jim Chanos was speaking at the Ira Sohn Conference last month, and presented his case for short-selling shares of hard-drive maker Seagate Technology PLC (NASDAQ:STX) based upon his belief in the death of the PC and heavy insider selling of shares. While Mr. Chanos has achieved an enormous amount of success short-selling stocks, this particular technique is not one to which I subscribe; however, when someone of his stature offers an opinion, it is always wise to take note.
Over the past year, shares of Seagate Technology PLC (NASDAQ:STX) have delivered quite an exciting ride to shareholders as they rocketed up 105% from a low of $21.62 to a high of $44.44 in May. It takes some conviction to consider shorting shares of a stock with this kind of upward momentum driving it; so I was interested to see the numbers that could have led to such a conclusion. I personally believe that the obituaries proclaiming the “death of the PC” are premature and overblown; after all, I can remember the pronouncements of the decline American manufacturing from my childhood and the predictions of our future demise as the world’s largest manufacturer, yet I continue to be employed in an American manufacturing and we still lead the world today.
Seagate Technology PLC (NASDAQ:STX) currently offers shareholders an attractive dividend yield of 3.53% that only requires a payout ratio of 19%. With price to earnings ratios of only 8.17 times and 7.87 times respective 2013 & 2014 earnings, the shares appear to be cheap. A bit more investigation also reveals that, over the past 5 years, the business has produced average returns on equity and capital of 20.1% and 10.9%. This just isn’t looking like a business to sell short; but they are also past results.
With a debt to equity ratio of 0.75 and annual sales growth of only 5.63% over the past 5 years, the business model begins to show some weaknesses. The 5.2% net margins are also weak for a technology business. One key point in the presentation Mr. Chanos delivered highlighted the high percentage of the total cost, “approaching 10%”, of a PC that is represented by the hard drive. The drive makers can expect enormous pricing pressure going forward and, as demand for their product slows, excess capacity will drive prices lower. Given the forward projected earnings growth rate of 1% annually for the next 5 years, Seagate Technology PLC (NASDAQ:STX) no longer appears to be so inexpensive.
Is this the same story with a different name?
Western Digital Corp. (NASDAQ:WDC) is another major manufacturer of hard drives for PC’s and laptops. While its production of solid state drives and networking products provide it with a bit more diversification than I see in Seagate Technology PLC (NASDAQ:STX), hard drives are the primary revenue producer for the company.
On the surface, the numbers for Western Digital Corp. (NASDAQ:WDC) look very similar to those of Seagate with the exception of the debt to equity where Western Digital Corp. (NASDAQ:WDC) carries a ratio of only 0.24 compared to the 0.75 of Seagate. As with Seagate, the 2013 and 2014 price to earnings ratios are very reasonable at 7.6 times and 8.11 times earnings respectively. The 5-year average returns on equity and capital at 24.3% and 20.8% are truly impressive but once again, these numbers indicate past results and we invest for the future.
The 5-year forward consensus earnings growth projection for Western is only 2.5%/year which also serves to confirm the dismal forward prospects for Seagate. Considering the dividend yield and growth rate, I would not expect to pay more than 4 times to 5 times 2014 earnings for Western Digital Corp. (NASDAQ:WDC) at this time and it is currently much higher than that.