Puff Puff Cash: Bargains in Clouds?
T. M. is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
New technologies are prone to volatility -- just ask anyone who rode the end of the dot-com era to its bitter lows. Yet we keep coming back: new technologies can fundamentally alter our commerce and culture, which can mean strong growth for the investor.
The use of cloud storage is an increasingly common practice among both consumers and businesses. We are, after all, suckers for the convenient. As we move away from old-school personal data storage, companies like EMC Corp (NYSE: EMC), Seagate Technology (NASDAQ: STX), and Xyratex Ltd. (NASDAQ: XRTX) are positioned to manufacture the data storage devices to meet this growth, as well as maintain the digital infrastructure of their clients for years to come. Everyone rises on a cloud of cash & convenience, end of story.
And yet… despite the increased need for data storage and accessibility, many smaller data storage companies' stock remain depressed; are these undervalued bargains, or have they been effectively pushed out by larger competition in a blooming technology?
Castles Made of Clouds
First, let’s look at what qualifies as the “larger competition”. High above the mucky-muck, EMC sits comfortably atop the data storage industry with a market capitalization of $58.2B, the greatest in the U.S. for their sector; their net income marches reassuringly forth at an average of 20% YOY for the last three years, and their debts remain wholly manageable, leaving the prospective investor comfortable with the business’s general profitability.
Perhaps most important (for the long-term investor) in an infant sector such as this, ECM’s R&D has increased YOY by 8% for the last four years; last quarter alone, 17.6% of gross operating income went towards R&D, suggesting a business that intends to continue dominating the field.
Good news all around, though not shut-up-and-take-my-money news: EMC’s PEG ratio is at a fair 0.9, and their price-to-book ratio sits at a modest 2.6. The company is certain to remain solvent and profitable and even grow considering its sound finances and size, but what about its smaller, leaner, cheaper competitors?
Seagate comes in below EMC in terms of market share with a capitalization of 'only' $11.9B, but this nevertheless positions Seagate far above the majority of its competitors. With a YOY increase in net income of 460%, its rise from the dark days of 2009 has been... notable, and its return on equity of over 90% is impressive. This is a company that works hard to make your investment count, as Seagate continues to feed a steady stream of revenue into R&D. Last quarter research and development accounted for 18% of gross operating income allocation. But wait, there's more! Seagate offers a substantial dividend of 4.3%.
So... buy Seagate! Perhaps. Price-to-book remains high at 3.7, suggesting a stock that may have grown somewhat overvalued, though considering the massive growth being seen at Seagate, it may not be so undeserving of its price after all. Its current ratio hovers below 2, meaning that Seagate's financials are not entirely in order -- though with a debt-to-equity ratio of 0.8, don't expect much volatility in future earnings. Perhaps a slow decline or a leveling off of this incredible growth. As it is, if Seagate can ride the cloud computing wave, I would expect it to experience yet more gains in the market like it has seen this year, tripling from its 52-week low.
Tomorrow's Technologies On The Cheap?
Those are the fairly-priced, high-performing, higher-cap cloud computing stocks... but investors are always looking for the little stock that’ll make it rain today, not yesterday, aren't they? U.K.-based Xyratex is currently trading around 18% above its 52-week low, but with Zack’s forecasting a steady increase in EPS (though I try not to put too much faith in analyst crystal-balling…); their financials bear a closer look. What we see is a business struggling: net income dropped 80% YOY, and revenue has shrunk since May of last year, averaging -13% the past five quarters. Nevertheless, their current ratio is at 2.67, indicating that they are financially sound; they can and will weather these struggles.
Meanwhile, Xyratex continues to roll out new products and invest in its future. The company’s return on equity is a respectable 12%; they’ve invested nearly half of their operating profit into R&D for three of the last four quarters – suggesting a growing company with its eye on the future. Who wants to invest in a company that doesn’t invest in itself? Considering that their price-to-book ratio is at safe 0.7, the stock as it is may turn out to be a bargain in the months to come. That the stock offers a dividend yield of 3.1% is not too unattractive, either; it may; after all, be some time before Xyratex once again rises into 'sell' territory.
Mom Always Said, “You Get What You Pay For”
What can we take from this? Larger data storage businesses like EMC and Seagate are positioned for more reliable, but perhaps less exciting, growth, if for no other reason than because of rising demand, sound financials, and their comfortable positioning as industry leaders. Meanwhile a company like Xyratex, while a loser today could very easily become a winner tomorrow should it recover from its slump and ride the wave of growth in its sector; we'll be looking at other small-cap data storage stocks soon. Other data storage businesses offer other opportunities, all dependent on how much risk you can tolerate. While smaller stocks can grow quite large, all too often it turns out there was nothing there but air.
tmloyd has no positions in the stocks mentioned above. The Motley Fool owns shares of EMC. 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.