I believe in growth stocks. As an analyst for our Motley Fool Rule Breakers service, I think you should be a believer, too. But even I have to admit that some growth stories are bogus -- hence this regular series.

Next up: SanDisk (Nasdaq: SNDK). Is this specialist maker of flash memory technology the real thing? Let's get right to the numbers.

Foolish facts



CAPS stars (out of 5) ****
Total ratings 2,011
Percent bulls 92.5%
Percent bears 7.5%
Bullish pitches 328 out of 350
Highest rated peers Synaptics, China Digital TV, EMC Corp.

Data current as of Jan. 28.

SanDisk itself isn't sexy, but it operates in one of the sexiest areas of the tech market: mobile devices. The company's flash memory chips have become a staple for a new generation of tablets, smartphones, and related consumer electronics. Intel (Nasdaq: INTC) and Samsung license SanDisk's technology, and LG Electronics is a significant customer.

Business has been good. Revenue rose 35% for the year, with earnings more than tripling from the previous fiscal year. In the fourth quarter alone, EPS improved 39% to $2.01 a share. The report added a strong ending to a smart prediction by my Foolish colleague Eric Jhonsa, who named SanDisk as his pick for the Best Tech Stock of 2010. The stock ended last year up 72%.

"Tech sector [is] just ramping up. The memory and storage sectors have room to grow with cloud computing advancing and more data centers getting upgraded. Solid-state drives are also entering the consumer market (e.g., retailers) with increasing strength," wrote Foolish investor Skyshark29 in November.

Fair enough, but expectations may have run ahead of reality in recent weeks. The stock fell more than 10% following the release of those strong fourth-quarter earnings. Year-to-date, shares of SanDisk are down about 9%.

The elements of growth





Normalized net income growth 189.3% Not measurable Not measurable
Revenue growth 35.3% 6.4% (14%)
Gross margin 47.1% 36.4% 4.3%
Receivables growth 27.6% 41.6% (64.1%)
Shares outstanding (million) 235.2 228.7 226.1

Source: Capital IQ, a division of Standard & Poor's.

Investors may be rushing out of the stock because history says a memory-market downturn is inevitable. Maybe they're right. But if they are, you wouldn't know it from looking at the numbers. Let's review:

  • With revenue growth accelerating as margins expand, it appears that SanDisk has both operating leverage and pricing power. Free cash flow has ballooned as a result, tripling to more than $1.3 billion during 2010.
  • Growth is primarily responsible for the gain, but good management also played a part, as receivables grew much slower than revenue last year. Big profits followed.
  • SanDisk has a history of increasing its share count, but this appears to owe as much to employees' exercising stock options than anything else. So far, the dilution hasn't hurt outside investors.

Competitor and peer checkup


Normalized Net Income Growth (3 yrs.)

Micron Technology (Nasdaq: MU) Not measurable
SanDisk 50.8%
Seagate Technology (Nasdaq: STX) (3.8%)
STEC (Nasdaq: STEC) 26.1%

Source: Capital IQ. Data current as of Jan. 28.

Among competitors, only solid-state drive specialist STEC gets close to SanDisk in terms of long-term growth. Both are also well-positioned for future growth. Analysts expect SanDisk and STEC to enjoy annualized profit growth of 12.5% and 16%, respectively, over the next five years.

Grade: Sustainable
In this case, Wall Street may be too cautious. Android-powered tablets with SanDisk flash technology are only now being introduced. Solid-state drives also have yet to go mainstream. Either technology could take off in 2011, and in the process lift the fortunes of SanDisk and its investors.

Now it's your turn to weigh in. Do you like SanDisk at these levels? Let us know what you think using the comments box below. You can also ask me to evaluate a favorite growth story by sending me an email, or replying to me on Twitter.

Interested in more info on the stocks mentioned in this story? Add Intel, Micron Technology, SanDisk, Seagate Technology, or Synaptics to your watchlist.

China Digital TV is a Motley Fool Rule Breakers recommendation. Intel is a Motley Fool Inside Value pick. Motley Fool Options has recommended buying Intel calls. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is a member of the Rule Breakers stock-picking team. He didn't own shares in any of the companies mentioned in this article at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. You can also get his insights delivered directly to your RSS reader. 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 owns shares of EMC and Intel, in which it also owns calls. The Fool is also on Twitter as @TheMotleyFool. Its disclosure policy thinks Monty Python is sustainably funny.