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Has Western Digital Become the Perfect Stock?

http://www.fool.com/investing/general/2012/09/07/has-western-digital-become-the-perfect-stock.aspx

Dan Caplinger
September 7, 2012

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 (Nasdaq: 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% 17.9% Pass
  1-Year Revenue Growth > 12% 31% Pass
Margins Gross Margin > 35% 29.2% Fail
  Net Margin > 15% 12.9% Fail
Balance Sheet Debt to Equity < 50% 28.5% Pass
  Current Ratio > 1.3 1.77 Pass
Opportunities Return on Equity > 15% 24.5% Pass
Valuation Normalized P/E < 20 7.98 Pass
Dividends Current Yield > 2% 0% Fail
  5-Year Dividend Growth > 10% 0% Fail
       
  Total Score   6 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Western Digital last year, the company has picked up two points. The stock has done even better, rising more than 50% over the past year.

Western Digital has been through a lot in the last year. Last fall, the company suffered greatly as flooding in Thailand caused severe damage to its production facilities. By contrast, rival Seagate Technology (Nasdaq: STX  ) wasn't hit nearly as hard, giving it a major competitive advantage over Western Digital.

Yet even though it took several quarters for Western Digital to catch up, it managed to bounce back a lot faster than many had thought. As early as January, Western Digital benefited from substantially higher prices from the much-reduced supply of hard drives, making up for production cuts and actually improving gross profits. The completion of its acquisition of Hitachi in March also eliminated a competitor.

Rising hard-drive prices,