Looking For Value Stocks for 2014

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Fundamentally I guess I'm a value guy; in fact, on reflection, I suppose we all are. Everybody is looking to buy things that are undervalued. As 2013 draws to a close, however, that presents quite a problem. This year has seen record highs on the S&P 500 and the Dow after a great run. This is obviously good news for investors generally, but for we pundits charged with coming up with ideas for next year, it's a challenge.

As you can imagine, with the S&P 500 (SPX) up over 27% since the end of last year, finding individual stocks or sectors that are basically cheap has become a little difficult. It is easy to perceive false value in fallen giants such as Blackberry (BBRY) or JC Penney (JCP), but in both cases, the big drop in the stock this year has been fully justified. When a company has done well, the general upward momentum has resulted in some valuations becoming extremely rich. Both Tesla (TSLA) and Twitter (TWTR), for example will have to do the most basic thing required of a business and make a profit before I have any faith in them.

Despite all of that, though, there are some areas that don't look to be in trouble, in fact have appreciated this year, but could still be said to represent value. Hard drive manufacturers have had a tough time of it while the rest of the economy was gradually recovering. The much heralded "death of the PC" and the shift to mobile created problems for the industry coming out of the recession. After much consolidation and capacity reduction (read: bankruptcies and fire sale buy-outs) two companies are left dominating the market. Western Digital (WDC) and Seagate Technology (STX) between them account for around 90% of hard drive sales.

STX

As you can see, neither has had a bad year. WDC is up 94.5% and STX, the slacker, has gained about 84%. Normally, when I look at a year like that, I am looking for proof that a stock or sector is now overvalued, but neither WDC nor STX look that way.

The market dominance that I spoke of before has come about as the market was shrinking, but has left both companies poised to take off if and when that trend ceases, and there are signs that that is beginning to happen. It’s not that we are suddenly reverting to PCs, nor ever will.

It’s that we live in a world of big data.

That data has to be stored somewhere and it would take a mighty big filing cabinet if it were stored in print form. As the sheer volume of little gems about our online and mobile lives grows, so does the demand for hard drive space. This is nothing new and to some extent explains this year’s performance in the sector, but, interestingly it still doesn’t seem to be priced in.

Both WDC and STX are trading at a Price to Earnings ratio (P/E) around 10; a serious discount to the market as a whole. This doesn't necessarily mean that they are cheap, but when you consider that the ratio of Enterprise Value (EV) to Revenue is 1.1 for WDC and 1.3 for STX it begins to look as if there is room for expansion there and any revenue growth could have a significant effect on price.

As somebody who looks for value, there is something fundamentally distasteful about a stock or sector that has seen the kind of performance that hard drive manufacturers have this year. Western Digital and Seagate, however, started from such an undervalued position that there could still be plenty of meat left on the bone. I doubt they will repeat this year’s performance and come close to doubling, but it wouldn’t come as a surprise if they once again outperform the market as a whole.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks , Technology

Referenced Stocks: BBRY , JCP , STX , TSLA , TWTR , WDC

Martin Tillier


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