Do Not Invest in Computers, Invest in Hard-Disk Drives

Robinson is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The digital world is evolving at an amazing speed. Thus, the demand for digital storage grows stronger each day. Companies are in need of larger and faster hard-disk drives (HDD). Not long ago, HDDs of 200 GB or 500 GB were unheard of. Nowadays, 1 TB and 2 TB are the standard capacities for any personal computer.

Several factors have led to strong demand for HDDs. Nowadays, many digital TV boxes have DVR capabilities. Further, the Sony PlayStation 3 has 250 GB or more in HDD. Digital cameras have higher mega-pixels. For these reasons, hard disk drive manufacturers deserve attention to determine if they offer appealing investment prospects.

Hard disk drive kings

Seagate Technology (NASDAQ: STX) and Western Digital  (NASDAQ: WDC), two major players in the digital storage market, provide storage media ranging from personal computers to servers.

Valuation

From a valuation standpoint, Seagate trades with a price-to-earnings ratio of 6.8, while WD trades with a P/E of 7.7. Both companies trade well below the industry’s average of 15.1. Seagate’s ROA and ROE are higher than WD’s, with Seagate’s ROA and ROE at 26.6 and 71.8, respectively, compared to WD’s 14 and 25.1, respectively. Seagate’s balance sheet carries a considerable amount of debt, with a debt-to-equity ratio of 0.7. On the other hand, WD’s debt-to-equity ratio is in line with the industry’s average of 0.2.

According to their latest earnings report, Seagate’s revenue declined 21% to $3.5 billion, and its net income shrunk 65% to $416 million, or $1.13 per share. On the other hand, WD’s revenue rose 23% to $3.7 billion, and its net income declined 20% to $391 million, or $1.60 per share. WD had better revenue and higher operation margin than Seagate.

Seagate may be regarded as an income stock because of its juicy 3.5% dividend yield. The company hiked its dividend payment in December 2012. Further, a share repurchase program worth $2.5 billion was authorized in April 2012. Investors may expect an expansion of the share repurchase program soon because the company’s free cash flow increased significantly at the end of the last quarter from $1.3 billion to $2 billion.

Western Digital pays its shareholders a dividend of 1.5%. The solid free cash flow of $1.6 billion reported by the company is more than enough to cover the dividend payment. The company authorized a $1.5 billion share repurchase program to return capital to investors. However, I would expect an expansion of the program since the company is showing outstanding growth.

Although it may be argued that the introduction of the iPad by Apple has had a negative impact on HDD sales due to declining PC sales, I believe that there is not as big a problem. Granted, PC sales are declining significantly. However, the needs for digital storage media remains strong.

Tailwinds for Seagate and WD

Going back to Seagate, it should perform well in the future for the following reasons:

  • Solid-state drives are more expensive than regular magnetic hard-disk drives. It must be stated that Seagate is the king in HDDs.
  • The demand for storage media should be strong due to propagation of DVRs, video gaming consoles, digital camera, and music.
  • The “Cloud” technology is gaining popularity.

Western Digital will also perform well in the future for these reasons:

  • The company just acquired sTec. This transaction places WD in a better position towards the development of SSDs. sTec owns a substantial number of patents and technology that will enable WD to continue the development of SSDs.
  • The company is the other HDD king! I personally enjoy the WD “Green” HDDs that work with minimal power requirements. On the contrary, “Black” HDDs perform much faster, but require more power. This gives the flexibility to the end-user to buy the product that best suits their needs.

The Foolish conclusion

The performances of Seagate and Western Digital are remarkable. Despite the decrease in PC sales, these companies are still experiencing strong demand for their products. For now, it is impossible to determine which offers the best investment prospects. Thus, I would recommend buying both companies as a basket for they will provide growth to your portfolio.

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Robinson Roacho has no position in any stocks mentioned. The Motley Fool owns shares of Western Digital.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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