Buy Alert: Western Digital (WDC)

Date: May 1, 2018

EQUITY TRADE INSTRUCTIONS

Symbol: WDC (NasdaqGS)
Limit:
 Buy below $83
Holding Period: 5 months
Target Price: $95
Target Gain: 14.5%

OPTION TRADE INSTRUCTIONS

Symbol: WDC181019C00080000
Limit:
 Buy below $7
Strike Price: $85
Expiration Date: October 19, 2018
Target Gain: 42.9%

COMPANY DESCRIPTION                     

Western Digital Corporation, together with its subsidiaries, develops, manufactures, and sells data storage devices and solutions worldwide. It offers performance hard disk drives (HDDs) that are used in enterprise servers, data analysis, and other enterprise applications; capacity HDDs and drive configurations for use in data storage systems and tiered storage models; and enterprise solid state drives (SSDs), including NAND-flash SSDs and software solutions that are designed to enhance the performance in various enterprise workload environments. Link to company website.

TRADE RATIONALE       

Western Digital’s sell-off over the past two days has been excessive, especially since the company reported outstanding quarterly results that included a bump to this quarter’s earning guidance. However, all of that good news wasn’t enough to offset a comment made by the company’s CEO, Stephen Milligan, who indicated that profit margins may shrink in the future as prices for its 3D NAND memory devices “normalize” after jumping more than 14% during the past quarter.

Immediately after the financial results were released – but prior to the commentary from Mr. Milligan – shares of WDC rose 3% in after-hours trading. At that price, WDC is valued at a little over six times forward earnings, which is nearly two-thirds less than the average FPER (forward price to earnings ratio) of the S&P 500 Index. Even if declining NAND prices cut the company’s profit margin in half, it would still be priced at a 30% discount to the overall stock market.

In certain respects, Western Digital recent share price behavior, and that of its peers is similar to how the retail sector performed a year ago when the entire industry was under siege. From December 2016 thru August 2017, the SPDR S&P Retail ETF (NYSE: XRT) dropped 20% due to fears that earnings for most of these merchants would lose market share to Amazon.

However, over the following four months, this ETF fully regained all of that loss and then some. I believe a similar pattern will recur in this sector, with the rally led by grossly oversold stocks such as Western Digital. If so, then the $85 call option expiring in October could appreciate more than 40% if WDC gets back up to $95 by then. Less aggressive investors may choose to buy the stock, which would gain nearly 15% under the same scenario but with considerably less risk.

Stock Talk

Benny K

Benny K

Are you recommending the $80 call as explained in your Trade Rationale or the $85 call as shown in the Option Trade Instructions?

Jim Pearce

Jim Pearce

Hi Benny. Sorry for the error in the text, I am recommending the $85 call option. However, if you can pick up the $80 option for a decent price, then that would be a safer way to play it.

Howard

Howard

80 call filled at $6.50

Tom B

Tom B

Hi Jim:
Great idea! Instead I executed a put spread: buying the July 70’s selling the 75’s for a 1.40 credit. In my mind less risk, with a very nice credit.

Victor

Victor

Filled @ 78.40

Rick

Rick

Bought the Jun 18 $85 Calls for $2.99

Rick

Rick

Please ignore – wrong trade.

Rick

Rick

Bought the Oct 18 $77.50 calls at $8.13

Stanley

Stanley

WDC filled Oct. 85C for 4.95

Benny K

Benny K

Sold my $80 10/19/18 calls for 8.80. A nice 32% gain in 13 days. Will watch and may jump in again on a dip.
Thanks Jim

Jim Pearce

Jim Pearce

Hi Benny. I believe WDC will be a very tradable stock over the next six months, so you may be able to repeat your success with it more than once. Good work!

Dramatic License

Dramatic License

That’s great to hear! I sold today too, and since we have a lot of time on the trade, I think I can probably get back in later.

Jim Pearce

Jim Pearce

WDC is up 10% over the past week and is now above the $85 strike price. That call option (expires 10/19/2018) is now trading near $8, so everyone should be in a profitable position at this time. I am going to hang in there for the long haul, but anyone getting queasy on the overall stock market can bail out now and book a gain.

Dan

Dan

Thanks for the update. I was feeling conservative and went w/ Jan 19 $80. Wishing I’d done your recommended trade but cannot complain when I’m looking at a 50% gain in ~2 weeks.

It was really hard to convince myself to stay in on this one. Let me know if you change your mind about cashing in.

Dave

Dave

Not sure if this is the correct place to ask this question, but my WDC Oct call option has done very well since May 1st when I purchased it. I would like to protect that gain without exiting since the stock price is still $6 away from your target price and I think there may be more upside here. How can I accomplish my goal of staying in while protecting the gain?

Jim Pearce

Jim Pearce

Hi Dave. You should be able to place a Sell Stop Order on that option with your broker that will be executed if/when the option drops to whatever value/limit you specify: http://www.call-options.com/stop-orders-to-sell-options.html.

Dave

Dave

Thanks Jim!

Dave

Dave

I was thing about buying some DESP which you recommended back in Feb. The buy below price was $30, and then you list $24 as the support price. What exactly does the support price indicate? It seems like a good buying price (just over 24) right now, but if the support number indicates something is amiss, I would not want to buy.

Jim Pearce

Jim Pearce

Support is a technical indicator that is based on patterns in recent trading history. Since a lot of options investors factor technical indicators into their trading strategies, we provide that data point as an FYI so each person can decide if they want to use it.

Asjad Shamim

Asjad Shamim

Is this good time to jump in back?
Curious to see as this recommendation is still open 🙂

Jim Pearce

Jim Pearce

I think so, and the trade is still open provided it is below the buy limit and has not been closed out yet. WDC is currently valued at less than six times forward earnings, which is either absurdly low or indicative of an impending implosion of demand for cloud storage which seems far-fetched to me.

Janis Bell

Janis Bell

If going for an option (since I already have a small long position in WDC), would you still recommend the 85 strike (oct 19) now down to 2.22, or would it make more sense to do an 82.50 @ 3.55; 80 @ 4.55; or a 77,50 # 5.44? (Assuming recommendation was to buy a call)
Would be happy to hear from anyone — the option value goes up as the stock price gets closer to the strike price, but what happens if it goes above the strike price? Thanks 🙂

OR

OR

Hi Jim, Just wondering if WDC fundamentals has changed or company challenges added.

Jim Pearce

Jim Pearce

We’ll find out in a week when the company releases its next set of quarterly results next Thursday (https://finance.yahoo.com/news/western-digital-sets-july-26-150000271.html) because the valuation doesn’t make much sense at the moment. WDC is currently priced at 1.1 times sales and less than 6 times forward earnings, both of which are too low unless there is something we don’t know about it yet. There is enormous implied volatility in the options expiring next Friday, so it looks like a lot of people are betting on a big move one way or the other after those results come out.

Jim Pearce

Jim Pearce

WDC released solid Q2 results yesterday accompanied by a new $5 billion share repurchase plan: https://finance.yahoo.com/news/western-digital-announces-financial-results-201000630.html. Nevertheless, it is trading lower this morning. I admit I am confounded by WDC’s current valuation, now less than six times forward earnings and only one time sales. I suspect there may be some algorithmic program trading at work that has pushed WDC into a downward cycle, in which case it could bounce back strongly early next week once those trades clear. As a matter of policy we do not “double down” on any of our trades, but if ever there was a situation that called for it this may very well be it.

Asjad Shamim

Asjad Shamim

Hi Jim, Thanks for the update.
Agree very confusing on why stocks plunged that much today. Hope it bounce back.

Dan

Dan

Thanks for the update. I went for the aggressive double down with Jan $75 calls.

Asjad Shamim

Asjad Shamim

Last week i bought as well with different strike price but WDC went down today further lol
Hope it bounce back soon.

Asjad Shamim

Asjad Shamim

Is there any news which caused WDC to move down trend though earnings were okay?

Jim Pearce

Jim Pearce

The company announced a new $5 billion share repurchase plan, so presumably that isn’t the problem, either. Even though WDC is now priced at just 6 times forward earnings, it’s trailing PER of 103 could be a problem since many algorithmic trading programs would view that number has excessively high. If that is the case then WDC should rally once the trailing PE number starts to come down later in the year.

OR

OR

Was the trailing PER number known or how is it measured for it to surface now? Later in the year. Thoughts on Options expiring in October.

Jim Pearce

Jim Pearce

Yes, the trailing PER is a known number since it is based on the sum of reported earnings over the previous four quarters. As for the option expiring in October, obviously at this point it seems unlikely that WDC will get back above $85 within three months given where it opened this morning ($69). However, I believe it could get back in the $75 – 80 range by then, so it might make sense to roll this trade down to a lower strike price between now and then.

Stanley

Stanley

Hi Jim,
I was not part of the original WDC trade, I was debating coming in @67.50 @4.40
or $65.@ 6.00.
Not sure if I should enter the trade.
Do you think it is still a viable trade?
Thanks

Stanley

Stanley

Do you think the announced dividend of .50 is having a negative effect on the stock?

Jim Pearce

Jim Pearce

No. It’s not like WDC has better things it can do with that money, otherwise it wouldn’t have announced a new $5 billion share repurchase plan. This is a valuation problem, plain and simple. The only way to justify a valuaton multiple of 6 times forward (next 12 months) earnings is if you believe profitability will decline even more after that. Based on the company’s estimates, the decline in profits will bottom 6 – 9 months from now and then begin increasing. If that turns out to be the case then the stock is fundamentally mispriced. For that reason (in response to your first question), I still think this is a viable trade but at this point I would go with a lower strike price if you are going to use that same expiration date.

Asjad Shamim

Asjad Shamim

Hi Jim,
Thanks for the feedback and update.
Understood it will tough for WDC to come back to $85.

I have three positions at WDC (three different strike price) and all of them expiring in Jan 18 2019.
Currently i have lost on all three strike price as stock going down avg every day. Hoping it will kick back up. Even if it hits $80, believe i should be able to recoup the money i have invested in WDC.
Lets see how next month plays for WDC it may give some direction.
I have no clue what PER is will be asking you again on your thoughts in coming weeks on WDC 🙂

Jim Pearce

Jim Pearce

PER = Price to Earnings Ratio

Asjad Shamim

Asjad Shamim

Hi JIm,
Quick question/feedback.

It seemed WDC sinking every day and currently below $66.
Any thoughts on what could be going on? Any sign of rebound in coming days?

Jim Pearce

Jim Pearce

Although demand for HDDs (hard disk drives) is on the wane, Western Digital now derives only half its revenue from that segment so its hard to believe that alone explains the 30%+ share price drop since it peaked above $106 five months ago. Unless there is something else about the company we don’t know yet, I believe it is one of the most oversold stocks in the S&P 500 Index. From a technical perspective, WDC is near its lower Bollinger Band and has an RIS of 22 which suggests it is close to bottoming out.

Asjad Shamim

Asjad Shamim

Thanks Jim for the info.

Benny K

Benny K

Hi Jim,
You posted a reference to your buying Jan.2020. LEAPS in WDC on the Personal Finance site. Would you be willing to share the details of your trade and rationale behind it with the Systematic Wealth subscribers?

Jim Pearce

Jim Pearce

Dave

Dave

Jim, do you still like the “leap play” you discussed in September, even if buying today?

Jim Pearce

Jim Pearce

Yes, I do. WDC is scheduled to release quarterly results this Thursday, so we may see some positive movement in the stock then if forward guidance is better than expected (which is what I expect). Of course, if the overall stock market is tanking at the same time then it may be difficult to make much headway until that has run its course.

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