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Lutts Tells TopStock that Western Digital (WDC) is Poised to Go Higher

Reprinted from

Western Digital at Multi-Year High and Poised to Go Higher

By Timothy Lutts, Chief Investment Strategist and Editor of Cabot Stock of the Month Report
December 18, 2007

Western Digital Corp. (NYSE: WDC) is a leading maker of hard disk drives. Western Digital’s drives can be found in corporate servers, in desktop computers, in portable computers, in backup applications and in consumer electronics, like DVRs, gaming systems, karaoke systems and video surveillance systems. In short, they’re everywhere.

You can buy a Western Digital drive directly, but half the company’s output goes to original equipment manufacturers (OEMs) who put them in their own products.

As such, Western Digital is caught in a never-ending race to make its products better and cheaper, and to do it before the competition.

It’s a cutthroat business, and because of that, hard drive makers have never been great long-term investments.

No longer in business are old names like Integral, Tandem, Control Data, MiniScribe and Connor Peripherals. Little Iomega, a thrilling and very profitable investment back in 1995 after the Zip drive came out, has lost money in five of the last six years and was just “bought” (in a complex transaction) by Great Wall Technology, which is majority-owned by the Chinese government. Last year, Seagate bought Maxtor for $1.9 billion. And early this year, Western Digital acquired Komag for $1 billion.

That leaves only four companies—Western Digital, Seagate (NYSE: STX), Samsung, and Hitachi (NYSE: HIT)—manufacturing over 98% of the world’s hard drives. Samsung and Hitachi, of course, are electronic behemoths; hard drives are just a fraction of their business.

But why would you want to invest in a hard disk maker anyway? Because historically, these companies have provided many opportunities to make big money quickly, and it looks like we’re entering one of those periods today.

What typically happens in the industry is that as business improves and profits increase, companies expand so they can increase revenues. But the increased production, typically the result of expansion by several firms, means capacity begins to exceed demand, so manufacturers cut prices to move product. Trouble is, that reduces profitability, and as earnings fall, investors desert the stocks. And it’s not until demand for product increases and allows product prices to stabilize that earnings can creep up and the good times return.

All the while, of course, all companies are involved in the never-ending race to increase storage capacities and reduce prices.

So why is WDC attractive today? Because it’s strong ... stronger than Seagate and stronger than the broad market.

Right now, the industry’s fundamentals are outstanding—lower production from a couple of Asian competitors has kept inventory levels low, while demand remains very strong thanks to an explosion in mobile device sales (the firm’s mobile-related drive sales were up 55% in the third quarter) and healthy growth in computer and digital video recorder shipments. The result: Third quarter earnings crushed estimates by 39%, and the firm upped its fourth-quarter outlook. All told, we expect the positive news flow to continue for the intermediate-term.

WDC peaked at $25 per share in February of 2006, fell to $16 by March of this year, and has been strongly uptrending since. The best aspects of the chart, however, occurred just in the past few weeks—the surge at the start of November was caused by a great earnings report, the stock held up well during the market’s November slide, and it’s push to new multi-year peaks came on a higher fourth-quarter forecast. WDC is extended to the upside, but we don’t believe a big pullback will come. You can buy a little here, and look to add on strength.

But if you buy, I caution you not to fall in love with the stock. If you do, I guarantee it’ll break your heart.

About Timothy Lutts

Timothy Lutts heads one of America’s most respected independent investment advisory services, publishing seven newsletters to over 85,000 subscribers around the world. His dedicated team of professionals serves individual investors with high-quality investment advice based on time-tested Cabot systems. Tim also co-edits Cabot Market Letter and edits Cabot Stock of the Month.

As a teenager, Tim worked part time for his father, Cabot founder Carlton G. Lutts, when Cabot Market Letter was first published in 1970. After college, Tim worked for a variety of technology companies in the Boston area before returning to Cabot as a full time employee in 1986. He brought Cabot into the computer age, and then the Internet age, and became President of Cabot Heritage Corp. in 1996.

Under his leadership, Cabot newsletters have been honored numerous times by both Timer Digest and the Hulbert Financial Digest as the top investment newsletters in the industry.

Tim has appeared on numerous podiums as an investing expert including Bloomberg TV and the World Money Show, and led Investor’s Business Daily discussion groups. He holds a B.A. in English from Northeastern University.

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