This article is part of the Real-Money Stock Picks series.

Actually, I'm a bit torn with this decision.

You see, Western Digital (NASDAQ:WDC) has been one of my solid winners in the real-money portfolio I run for The Motley Fool (Messed-Up Expectations). I've purchased it five times so far between early 2011 and early 2013, with gains ranging from 83% to 208% -- and a total gain for the entire position of 136%, all as of last night.

All the valuation metrics -- P/B, P/S, P/E, EV/FCF -- were much lower back then than they are today, too. For instance, when I bought the fifth position last year, P/E was about 5.8. As of last night, that has risen to about 20.7.

Over the past year, free cash flow has dropped from $2.95 billion to $2.19 billion. The market is pricing in a 10.3% annual return if it holds FCF at that level in perpetuity.

From a valuation perspective, it looks more like I should not be buying shares today and instead call the company fairly valued.

Not so fast
However, there are three facts that seem to disagree.

First, Western Digital is in, essentially, a duopoly for the world's supply of digital storage (both harddisk drives and solid state drives) with Seagate Technology (NASDAQ:STX), with a relatively small portion left over for Toshiba.


Western Digital











Data from IHS iSuppli 

This gives Western Digital several advantages, including economies of scale and, to some extent, pricing power. Couple this with its strong R&D program bringing ever larger and better disk drives to market, and there's something to be said for this situation.

Second, data storage needs are expected to grow, tremendously, for the rest of this decade. Estimates put it at 34% annually, approaching 6,000 exabytes in 2020 from just below 1,000 exabytes needed this year, with especially large growth in enterprise system storage. (An exabyte is one million terabytes, and a terabyte is one thousand gigabytes.)

Third, the diversity of storage needs is leading to diversified storage solutions. Enterprise systems (the "cloud"), for instance, need several types of storage. For bulk data that is accessed less often, high-capacity HDDs are needed because they are relatively cheap (per terabyte). For data that is accessed often and needs to be delivered quickly, SSDs are used. There are also hybrid drives, with both HDDs and SSDs in one unit where space is at a premium, but both requirements are there (inside a tablet, for instance). Thinner, lighter forms are needed for consumer electronics of all types. And everyone wants energy efficiency, where the electrical cost to store and access data is as low as possible.

This gives Western Digital the opportunity to capture a lot of the value chain, offering value-add products that meet many, if not all, those needs. For instance, its recently launched helium-filled HDDs reduce turbulence generated by the spinning disks, yielding a 45% reduction in Watts used per terabyte of storage.

Add a bit more
Taking all this together, I think the opportunity facing the company outweighs concerns that the company isn't as cheap as it was when I first bought. (I certainly don't think it's overvalued.) Therefore, I'll be making a sixth purchase of Western Digital for the MUE portfolio as soon as Foolish trading rules allow.

Please come and discuss this decision, as well as learn what else is in the portfolio, at the dedicated discussion board.