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Thanks for the Memory: Data Storage Set to Rebound

When a sector gets unfairly punished, buying opportunities arise. Below, I’ll explain why beaten-down computer memory stocks are poised to bounce back.

Five months ago, I wrote about a stock that I felt was oversold and likely to appreciate in value once investors recognized its strong fundamentals and cheap share price (“What’s Up With Walgreens?”). I noted that Walgreens Boost Alliance (NSDQ: WBA) was priced like a value stock while improving revenue like a growth stock.

Turns out, I was a couple of months early in my assessment. After bottoming out below $60 in late June, WBA has rallied 15% over the past 10 weeks. It still has a ways to go before getting back into the black for 2018, but its momentum is now upward and investors no longer perceive Walgreens as Amazon (NSDQ: AMZN) roadkill.

Likewise, I now feel the same way about a number of computer memory stocks, including Western Digital (NYSE: WDC). Since peaking above $106 in March, WDC is now trading in the mid-$50s. That’s a huge decline for a stock that has posted solid financial performance so far this year.

A few weeks ago, Western Digital announced fiscal Q4 results that included $5.1 billion in revenue compared to $4.8 billion a year earlier. For the year, the company recorded earnings per share of $2.20 versus $1.34 in 2017.

However, analysts following the sector expect prices to plunge for the type of memory devices manufactured by Western Digital. For that reason, they have slashed their profit estimates for WDC and a slew of other companies, similar to what they did with retail stocks last year.

To be clear, even Western Digital acknowledges that it will most likely experience some margin compression later this year. However, its diverse product line allows it to emphasize those revenue streams that are more in demand at the moment as accentuated by the company’s CEO Steve Milligan, in this statement that accompanied those results:

“I am pleased with our financial performance as we report strong revenue, profitability and cash flow generation. The Western Digital platform allows us to continue to deliver differentiated financial performance enabling us to effectively navigate dynamic market conditions.”

Nevertheless, WDC has been flogged by the market and shows no signs of turning around anytime soon.

We’ve seen this movie before…

The same was true for many retail stocks a little over a year ago when the SPDR S&P Retail ETF (XRT) bottomed out near $38. However, after better-than-expected holiday sales results the XRT surged and recently traded above $52 for a 36% gain in just 13 months (see chart):

I suspect something similar will happen with WDC and many other data storage stocks during the next year. I don’t know what will trigger the turnaround, but sooner or later the market will figure out that it has once again underestimated the extent to which these companies will be able to manage their way through a temporary challenge.

One way to play a turnaround is to simply buy a diversified fund that owns the entire space such as the iShares PHLX Semiconductor ETF (SOXX). This fund has gone nowhere over the past six months and experienced record outflows last week in response to President Trump’s threat to slap additional tariffs on Chinese computer products.

If China retaliates in kind, many American tech companies will get hurt. However, if the crisis is averted that may be the spark that ignites a surge in memory stocks. In that case, outsized gains will most likely be realized in oversold stocks such as WDC.

Want to tap the outsized growth potential of stocks like Walgreens and Western Digital? My colleague Jim Fink, chief investment strategist of Velocity Trader, has devised a time-tested system to leverage these and other stocks for explosive gains.

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