Want to be a smart value investor? Pay attention to great stocks at deep discounts - like WDC

September 10, 2018

Want to be a smart value investor? Pay attention to great stocks at deep discounts – like WDC

Since mid-July, I’ve written twice previously about Western Digital Corporation (WDC). The first time I wrote about them, the stock was priced around $75 per share, and my analysis showed that was a nice price for a good company that had hit an all-time high at around $107 just a few months before. On August 9, I wrote about them again, because the stock had dropped even lower, to around $66 per share, but now also had its most recent earnings report to add to the mix. At a price that was about 12% lower than just a few weeks before, and with a terrific fundamental profile, what had been a “nice’ price for the stock was now looking like a “great” price. Fast forward a month, and as of this writing the stock is now below $58 per share. The fundamentals haven’t changed in four weeks, but in the last week or so the stock picked up some more negative momentum and is pushing to even deeper lows.

So what’s been driving the latest plunge, which has driven the stock down a little over 23% since my first post in July? Sometimes, the stock market makes sense – or at least, you can tie what a stock is doing at a given time to specific news, or to something about the underlying company that has some semblance of logic to it. Often, though, it’s downright maddening. I’ll admit that when I first saw WDC drop below $70 I struggled to tie it to anything concrete. I’ve kept digging, and while I think I’ve found a couple of threads to tie the decline to, the logic behind one of them makes me shake my head.

Shortly after my July post, WDC published its latest quarterly earnings report. The numbers were good across the board – every fundamental measurement I use in my analysis remained very healthy or improved, including the company’s Book Value. It was right after that report, however that the stock started to drop. At the same time, WDC’s only real competitor in the HDD space, Seagate Technology Plc (STX) released their own earnings report. STX’s report reflected a reality that seems to be scaring investors about either company, because sales of HDD storage continues to decline. In the consumer space, in particular, HDD clearly looks like a dying breed.

The picture for NAND and SSD storage – memory that is built on solid-state technology, and what has increasingly become the preferred storage type in the consumer market, including for personal computers of just about any type, tablets, and pretty much any type of mobile device – also appears murky, and that is another element that is working against the stock’s price right now. Multiple recent reports from industry analysts indicate that pricing for NAND memory is dropping amid concerns about oversupply as well as increasing competition in the space. That puts pressure on the second tier of WDC’s business strategy; the first tier continues to provide HDD storage to the enterprise and cloud storage market (where the larger capacities available from traditional drives is needed), while the second included the 2016 acquisition of SanDisk to put them at the front of pack in the consumer-driven NAND and SSD market.

The truth, of course is that with more companies like Micron Technology (MU), Intel Corporation (INTC) and others making forays into the space, it isn’t a given WDC will maintain their leadership position in this segment. Intensifying competition, along with high supply clearly is also playing a role right now in the stock’s decline and is a major centerpiece of every argument I’m finding against paying attention to this space right now. That is actually one of the biggest reasons that i continue to think the opportunity with the stock is even better today than it was a month ago.

Competition in any business segment is a normal thing, and while that increases the pressure on any company, a good management team doesn’t shy away from it. I really like WDC’s strategy, and I think that in the long run they’re doing the right things to keep their business growing. I’m even willing to concede that pricing pressures in the NAND and SSD space could impact the company’s earnings in the near term; but I think the market is over-selling that risk to the point that the stock’s incredibly deep discount now – more than 46% below its March high – is making the stock an undeniable bargain. Even the analysts that are writing scary predictions right now are putting the stock’s long-term target price at around $75, which is about 30% above the stock’s current price, and not too far from my own target, as you’ll see below.

Fundamental and Value Profile

Western Digital Corporation (WDC) is a developer, manufacturer and provider of data storage devices and solutions that address the needs of the information technology (IT) industry and the infrastructure that enables the proliferation of data in virtually every industry. The Company’s portfolio of offerings addresses three categories: Datacenter Devices and Solutions (capacity and performance enterprise hard disk drives (HDDs), enterprise solid state drives (SSDs), datacenter software and system solutions); Client Devices (mobile, desktop, gaming and digital video hard drives, client SSDs, embedded products and wafers), and Client Solutions (removable products, hard drive content solutions and flash content solutions). The Company develops and manufactures a portion of the recording heads and magnetic media used in its hard drive products. WDC’s current market cap is $16.8 billion.

  • Earnings and Sales Growth: Over the last twelve months, earnings  grew more than 29% while revenue growth was modest, posting an increase of almost 6%. WDC operates with a narrow margin profile of about 1%. By comparison, STX’s margins are around 10%. I believe the difference is a reflection of the company’s differing approach to growth; STX focuses almost exclusively on the higher margin aspect of increasing enterprise demand, while WDC takes a two-tiered approach by meeting enterprise demand for HDD drives while also pushing hard on innovation and evolution with NAND and SSD storage.
  • Free Cash Flow: WDC’s free cash flow is very healthy, at almost $3.4 billion. That translates to a free cash flow yield of almost 17%, which is much higher than I would normally expect given the company’s narrow operating margins.
  • Debt to Equity: WDC has a debt/equity ratio of .95. That number declined from a little above 1 two quarters ago, as long-term debt dropped by more than $1 billion. Their balance sheet indicates their operating profits are more than adequate to repay their debt, and with almost $5 billion in cash and liquid reserves, the company has excellent financial flexibility, which they plan to use to pay down debt, repurchase their shares and consider other strategic acquisitions.
  • Dividend: WDC pays an annual dividend of $2.00 per share, which translates to a yield of almost 3.5% at the stock’s current price. That fat dividend – quite a bit higher than the S&P 500 average, which is a little below 2% – is a good reason to think seriously about buying the stock and waiting out any near-term price volatility you might have to endure. It’s free money you don’t have to do anything for except to hold your shares.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for WDC is $38.53 and translates to a Price/Book ratio of 1.45 at the stock’s current price. Their historical average Price/Book ratio is 2.12. That suggest the stock is trading right now at a discount of a little over 31%, which is very attractive, since it puts the stock’s long-term target price at nearly $84 per share.

Technical Profile

Here’s a look at the stock’s latest technical chart.


  • Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s intermediate downward trend, and also informs the Fibonacci trend retracement lines shown on the right side of the chart. The stock broke below strong support from repeated low pivots since late last year at $75, which has really driven the stock’s bearish momentum. The Fibonacci analysis shown on the chart above makes it hard to see where the stock’s next support level is likely to be. The stock is currently plumbing lows not seen since late 2016, where previous pivots put the most likely support in the $53 range.
  • Near-term Keys: As you can see, the stock is already offering a massively discounted price relative to where I think it’s long-term potential lies. The truth is that if you went long on this stock in late July, you’re probably trying to decide what to do to manage the position now. I think there is more than adequate argument to hold on and ride out the stock’s current downward trend; but if you want to limit your risk, using a stop loss 25% below your purchase price would be a smart, conservative approach. If you’re thinking about trying to short the stock or start working with put options to take advantage of downside, the best signal for that kind of trade would come if the stock manages to break prior pivot support at around $53. That could see the stock drive even lower and into the mid-$40 range.