Times have been tough for Western Digital (NASDAQ:WDC) and Seagate Technology (NASDAQ:STX), the two largest manufacturers of hard disk drives (HDDs) in the world. Shares of both stocks have fallen around 40% since the beginning of the year.

That's because the HDD market is being cannibalized on the consumer end by flash-memory solid state drives (SSDs), which run faster, use less power, don't have damage-prone platters, and fit better in thin notebooks and tablets. Yet times are also tough in the SSD market due to the arrival of 3D NAND technology, which could cause SSD and HDD prices to reach price parity as early as next year.

Image source: Pixabay.

To survive in this rapidly shifting market, Western Digital and Seagate have both tried to diversify beyond HDDs. Let's take a closer look at their strategies, growth potential, and valuations to decide which stock is a better buy today.

The data-storage arms race
At the end of last year, Western Digital controlled 43% of the HDD market, Seagate controlled 41%, while Toshiba accounted for the rest. Between the fourth quarters of 2010 and 2014, global HDD shipments fell 16% from 167.5 million to 141 million, according to Storage Newsletter and Trend Focus. However, that decline was slightly offset by robust demand for cheap storage in cloud data centers.

To increase its market share in SSDs, Western Digital bought Hitachi's hard drive business, SSD manufacturer STEC, enterprise flash storage company Virident Systems, storage optimization software developer VeloBit, and flash storage array maker Skyera. In October, it agreed to buy flash storage giant SanDisk (UNKNOWN:SNDK.DL) for $19 billion. According to Kitguru's market share numbers, Western Digital now controls nearly 14% of the SSD market, making it the second largest player after Samsung (OTC:SSNLF), which controls 45%.

Seagate, which made more acquisitions than Western Digital to expand its HDD portfolio over the years, hasn't made as much progress in SSDs. Its only meaningful defense against Western Digital's shopping spree is a multiyear NAND supply alliance with Micron Technology, which controls about 10% of the SSD market.

Western Digital has better growth
Last quarter, Seagate's revenue fell 22.5% annually to $2.93 billion and missed estimates by $10 million. Enterprise, desktop, and notebook storage shipments all declined across the board, and margins slid from 28.1% a year ago to 24.2%.

Western Digital's revenue fell 14.7% annually to $3.36 billion in its most recent quarter, as gross margin declined from 30.1% to 28.9%. However, two-thirds of Western Digital's revenue came from non-PC markets, up from 55% a year earlier. Western Digital's enterprise SSD revenue climbed nearly 50% annually. Those numbers will likely rise even higher after the SanDisk deal closes. For the current quarter, Seagate expects revenue to fall 19% to 22% annually. Western Digital expects revenue to fall 13% to 15% annually during that period. Based on these numbers, Western Digital looks like a more solid investment than Seagate.

But Seagate also has fundamental strengths
Yet Seagate still has three distinct strengths -- valuation, buybacks, and dividends. Seagate trades at just 9 times earnings, which is significantly lower than Western Digital's P/E of 12 and the industry average of 20 for the data storage industry.

Over the past 12 months, Seagate spent 86% of its free cash flow (FCF) on stock buybacks. Western Digital, which spent 47% of its FCF on buybacks during that period, suspended its buyback program due to its acquisition of SanDisk. While a suspended buyback program isn't a huge deal, it indicates that SanDisk's multiples will slightly decline as it reduces the number of outstanding shares, making Western Digital shares look even pricier.

Seagate pays a forward annual dividend yield of 4.2%, compared to Western Digital's yield of 2.4%. Seagate has raised its dividend for four consecutive years, versus just two straight years for Western Digital. Western Digital has stated that it will keep paying its dividend, but future payout increases could be affected by the SanDisk acquisition.

The verdict
Western Digital and Seagate both face big near-term challenges, but I believe that the former is better positioned for long-term growth. Its acquisition of SanDisk, while costly, will help it pivot more smoothly into the SSD market, while synergies and expanded manufacturing capabilities will let it produce more storage devices at lower prices. Seagate is a fundamentally cheaper stock with bigger buybacks and dividends, but it will likely struggle to gain ground against Western Digital in both HDDs and SSDs.