The 10 Worst PC and Storage Stocks of 2010

It's been a pretty kind year to stock investors, with the S&P showing a 12.8% gain in 2010. Of course, kindness might still feel relative after a decade of negative returns that included the nauseating depths and panic of the financial crisis.

Still, not every stock sees gains when a rising tide lifts all boats. Here's a list of this year's 10 worst performers in the PC and storage industry, which ignores companies that have gone bankrupt or sunk below $200 million in market capitalization.

Source: Capital IQ, a division of Standard & Poor's. Only includes companies listed on U.S. exchanges that contain a market capitalization greater than $200 million.

When I compiled a list of the top 10 stocks in this industry, the lack of companies selling PC-related parts immediately jumped out. Not surprisingly, many of these stocks found their way on to the worst-performers list.

Looking at computer makers, both HP's and Dell's shares sunk last year. While the companies are largely known as computer makers, they've spent years undergoing a massive makeover into full-service IT firms that offer consulting services bundled with their hardware sales. In HP's case, it shifted from 67% of operating profits coming from its computer and printing business in 2005 to just 41% in 2010. Dell derives just 3% of operating profits through its consumer-focused business.

Rebuilding their businesses in the IBM mold can lead to much better profit margins, but also comes with significant risks. Looking at the two companies' storage situation helps illustrate the risks.

One of the key growth areas in IT spending is high-end storage systems that can be bundled with large orders. Both HP and Dell have tried pushing into this segment, but with research spending that badly trails competitors, instead of using internally developed solutions, they've had to engage in costly bidding wars to fill in technology holes in storage. Earlier this year, the two companies engaged in a nauseating back-and-forth bidding war for storage specialist 3Par. HP eventually paid more than 10 times sales for the company.

Another area of struggling companies on the list is hard disk drive makers. Both Seagate and Western Digital make the hard disk drives seen in both PCs and many servers. Unfortunately, this segment is under attack by smaller flash memory drives that have come to dominate the growing mobile segment.

However, the battle's not yet over for hard disk drives. While flash memory might prove superior on mobile products, hard disk drives are vastly cheaper in terms of price per gigabyte of storage. That's an important point, because the explosion of data means that IT departments will continue needing cheap means of storage in the coming years in spite of the limitations of hard disk drives.

There's no doubt both Seagate and Western Digital face headwinds. However, they're also priced as if their products will soon be obsolescent. Given their pricing, they might not be the sexiest growth stocks in the market, but the companies could still be outsized winners in the future -- especially Seagate, which has a larger focus on drives used in enterprise storage. That's a segment that is less susceptible to the shrinking demand seen in the consumer market.

Two companies on the list that come from winning end markets but still saw returns that lagged the market were STEC and QLogic. STEC produces flash-based solid-state drives for enterprise customers. While it sells to a small niche, it's one that's growing rapidly. Unfortunately for STEC, it spent the year working through a problem that emerged at the tail end of 2009. Largest customer EMC revealed that it had an excess inventory of STEC drives built up and took a break ordering more. That caused STEC's rapid sales growth to fall off a cliff. However, with the EMC build up now resolved and sales returning to their former rate with a more diversified customer base, STEC appears poised for a strong rebound. In QLogic's case, despite being in the booming server market, customers continue to gain price concessions from the company, and its core host bus adapter (HBA) market is rapidly maturing.

As we look back from 2010 and ahead to 2011, expect more of the same. Storage should continue to boom and the rise of smartphones and tablets should continue to be a dominant storyline. For companies like HP and Dell, the window on becoming a force in these markets is closing fast. 2011 might prove a make or break year for their consumer divisions.

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