Will These 2 Stocks Gain When They Beat the Street Again?
Harsh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The last time I was writing on Seagate Technology (NASDAQ: STX) a few days back, the company had posted a stellar quarter and its shares jumped with joy. The strength of Seagate’s earnings was passed on to its arch nemesis Western Digital (NASDAQ: WDC), and its shares rose 5% after Seagate’s report at that time. So, you would have expected Western Digital to return the favor when its turn to report earnings came. But, it didn’t turn out to be that way.
Western Digital posted a blowout third quarter, but saw its shares plunge 14%. In addition, the company took its rival Seagate along with it to the salon and made its shares take a 5% hair cut. Surprising, isn’t it? Well, if you happen to go through the earnings transcript of Western Digital’s call, you would see CEO John Coyne pointing towards signs of recovery in the market. Any day, for any industry, you would take that as a positive sign. However, that’s not the case in the hard-drive industry at the moment. Let’s see why.
After last year’s floods in Thailand disrupted the supply of hard drives, Seagate and Western Digital cranked up their prices to make the most of the demand-supply disparity. As a result, both these companies went on doing well, posting huge margins and huge earnings. For instance, Seagate’s gross margin was 37% in the previous quarter, double of what it was in the year-ago period; and Western Digital’s adjusted earnings leapt a whopping 281% from last year.
But what will happen after 2013, the time when it is expected that the industry will become normal? It’s a simple case of market forces at play. Prices of hard drives went up from as low as 50% to as much as 155% till February this year. However, as the industry gets back to normal, the supply curve will shift to the right, prices will automatically come down, and so will the margins and the earnings. So it won’t be prudent if investors keep expecting big numbers from these two memory giants.
To some, the steep drop in Western Digital’s and Seagate’s stock would have come as a surprise. However, while I was writing my Seagate post, the idea of what happens when things are again normal did come across my mind. But I let that pass since I didn’t want to spoil the good mood after Seagate’s stunning numbers. In my opinion, the present drop comes as a correction which the stocks needed to undertake.
We have a habit of checking out earnings after chucking out one-time items to arrive at the normal number. In this case, one needs to think of the high prices of hard drives as one-time gains and eliminate them if you are to check out your company’s true state. It is indeed difficult to do that. But it shouldn’t be difficult to predict that more such shocks might come in the future till the industry is operating in a normal environment and the market continues to factor the drop in earnings a couple of years down the line into the price.
Seagate has given a return of 80% so far this year and Western Digital has made its investors richer by 22%, and both are above the 18% return of the tech-heavy NASDAQ. But keeping in mind the events which unfolded late last week, it seems a zigzag road is on the cards ahead. So even if these companies beat the Street next time, investors should be entirely sure which way the stock is going before they begin celebrating.
TechJunk13 has no positions in the stocks mentioned above. 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. If you have questions about this post or the Fool’s blog network, click here for information.