Is Western Digital the Perfect Stock?

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Western Digital (NYSE: WDC  ) fits the bill.

The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
  • Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
  • Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
  • Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Western Digital.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

17%

Pass

 

1-year revenue growth > 12%

(3.3%)

Fail

Margins

Gross margin > 35%

18.8%

Fail

 

Net margin > 15%

7.6%

Fail

Balance sheet

Debt to equity < 50%

5.4%

Pass

 

Current ratio > 1.3

2.53

Pass

Opportunities

Return on equity > 15%

14.2%

Fail

Valuation

Normalized P/E < 20

13.36

Pass

Dividends

Current yield > 2%

0%

Fail

 

5-year dividend growth > 10%

0%

Fail

 

 

 

 

 

Total Score

 

4 out of 10

Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.

With four points, Western Digital doesn't store enough points for perfection. The hard drive maker may seem like it has outdated technology, but it's still going strong despite some weakness in computer shipments.

Looking at the world of technology today, you might think that Western Digital's days were numbered. With PC sales giving way to smartphones and tablets that use solid-state memory from companies like SanDisk (NYSE: SNDK  ) and Micron (Nasdaq: MU  ) , hard drives seem destined to be the early 21st century's equivalent of the buggy whip.

But that way of thinking ignores the reality of the global economy. According to Intel (Nasdaq: INTC  ) , emerging markets are still thriving on largely unbranded computers that rely on the low-cost storage that hard drives from Western Digital and Seagate (Nasdaq: STX  ) produce.

Earlier this year, concerns about a glut of hard drives from Seagate, Hitachi (NYSE: HIT  ) , and Western Digital kept their stocks under pressure. But more recently, inventory levels have stabilized, suggesting that at least for now, the market is in better shape than it was at the beginning of 2011.

Eventually, if solid-state drive prices fall in line with hard drives, then Western Digital could be in trouble. But under current conditions, the company is in a strong position to benefit from emerging-market growth -- and has an attractively cheap valuation as well. Western Digital isn't perfect, but it could potentially produce nice returns for investors.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

Click here to add Western Digital to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Finding the perfect stock is only one piece of a successful investment strategy. Get the big picture by taking a look at our "13 Steps to Investing Foolishly."

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Western Digital and Intel and has bought calls on Intel. Motley Fool newsletter services have recommended buying shares of and creating a diagonal call position on Intel. 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 Fool has a disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 09, 2011, at 5:30 PM, ldkoehler wrote:

    PC sales are on the decline and hard drives sales are being threatened by high performance SSDs. Is WDC in trouble? Perhaps, but the market is overestimating the impact on WDC and creating a good buying opportunity for investors.

    WDC's current stock price of ~$28.31 implies that the company's cash flows will drop by 40% and stay there forever. With a current ROIC of 22% and a 9 year average ROIC of 37%, WDC is well positioned to beat market expectations.

    For more information on how to make money picking stocks, see: http://blog.newconstructs.com/2010/05/19/how-to-make-money-p...

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