Sometimes, I like the stocks I write about so much, I buy them for myself.
This is the case with Western Digital Corp. and Seagate Technology, two makers of computer disk drives I recommended a year ago. They seemed absurdly cheap then, with price-to-earnings ratios in the low single digits.
Since then, they have returned nearly 50 per cent and 30 per cent, respectively. And they're still cheap, particularly for the tech sector.
But I'm happy now to take my profits and go home. I see enough potential downside in these names to make me take a pass on whatever upside there is from here.
My theory a year ago: Undue pessimism about the personal-computer industry was causing investors to ignore rapidly expanding earnings from the two companies. "When we all ditch our PCs and live in the cloud with our tablets at the ready, what use are those old-fashioned spinning disk drives?" I asked.
I am, frankly, lucky this recommendation panned out. In 2011 and 2012 I made a number of picks that I defended, essentially, with "the future isn't happening as fast as the futurists say it is." Nearly all of them were wrong. ("Supremex: People are still using envelopes!")
I wised up and got out of the way of that particular train. When techies noted that chips made for personal computers fell below 50 per cent of all chip shipments, I went negative on names like Dell Inc. and Hewlett-Packard Co.
Since then, well, things are moving faster than expected. Tracking company International Data Corp. reported a nearly 14 per cent decline in PC shipments in the first quarter, compared with the prior year. This was the worst quarter in the two decades IDC has tracked the PC market.
It's this macro trend that prompted short-seller Jim Chanos, of Enron fame, to make a presentation last week bashing the disk-drive industry and naming Seagate, specifically, as his top short pick. (Short-sellers profit when shares decline.)
Mr. Chanos says increased use of mobile devices, and use of the cloud, reduces hard disk drive demand. PC makers, pressured by low margins, should in turn push for lower drive prices, which will crimp the drive-makers' profits. "We think that mean reversion will happen in this business, sooner rather than later," Mr. Chanos said, according to Bloomberg News.
He targeted Seagate in particular because of recent insider selling. "I think it'd probably be best if you did too," he said, according to the website Business Insider.
What do the analysts have to say? A number have scaled back their ratings as the two companies' shares have risen: Both have hit 52-week highs this month that are more than double their 52-week lows. Their forward price-to-earnings ratios, still very reasonable at about eight, are roughly double what they were a year ago.
Still, a number say that the PC impact is overstated, because each company has an enterprise business that benefits, not declines, with the growth of the cloud. Analyst Cindy Shaw of Discern Group Inc. says Western Digital told investors that PC drives will be less than 50 per cent of revenue in its current fiscal year. "We think the 'PC is dying' thesis has been an overhang … quantifying the impact should be a net positive."
Richard Kugele of Needham & Co. was less polite, dismissing Mr. Chanos in a note to clients by saying "It is always best to show up to class having read the material."
"The drive industry has never been so disconnected from the PC industry," Mr. Kugele says, arguing demand exceeds supply by two to three times. "One of the primary reasons for this increased data demand is the cloud, where data growth is by some estimates increasing 50-70 per cent per year. Cloud providers consume nothing but the highest capacity drives in huge volumes."
Mr. Kugele, who has a "buy" on Seagate and "strong buy" on Western Digital, with price targets about 10 per cent above current levels, says "we think contrarians shorting them put themselves at risk."
Fair enough. But for investors who bought in at 2012 lows and now have gains of nearly 100 per cent? It might be time to trim the position and take some returns that are sky — or maybe cloud — high.