From the March 1998 issue of Entrepreneur

The company: Irvine, California-based Western Digital Corp. is the third-largest manufacturer of PC hard drives.

The markets: The company sells to major computer manufacturers, including Compaq, Dell and Gateway 2000. It also sells hard drives for workstations, LAN servers and multiuser systems.

The sizzle: Following pricing turmoil and inventory gluts in the hard-drive industry during 1997, many industry-leading stocks are trading at cyclically low multiples while still sporting long-term, market-beating growth rates. Industry stocks have a better risk-to-reward ratio than they have had in some time. The hard-drive industry is expected to grow 18 percent to 22 percent annually over the next five years; Western Digital is expected to grow 20 percent annually--though bumps in the road are a given.

The risks: Price competition is one risk, along with demand levels. When necessary, disk drive makers lower their prices based on competitors' prices, which lowers margins and can impact profitability. Over-supply can lead to even lower prices. These factors drove industry stocks (and earnings) lower in 1997. A rebound is hoped for in mid-1998 and in 1999. Meanwhile, Western Digital has gotten out of the 3-inch portable hard drive business to focus on higher margin business. This type of change can be considered risky, but it's a step in the right direction.

Historical financial performance: Fiscal '97 was the strongest year in Western Digital's history, which began in 1970. The year ended with the company's 16th consecutive quarter of profitability. Revenue in fiscal '97 was $4.18 billion, a 46 percent increase from fiscal 1996. Earnings per share rose more than 200 percent last year, to $2.85 per share. Net profit margins climbed above 6 percent from 3.3 percent. As of late 1997, the company had $184 million in cash and no long-term debt. The stock has returned 39 percent for each of the past five years.

Projected financial performance: Western Digital is expected to grow earnings per share to $1.05 per share in fiscal '99, following a decline in earnings per share in the current fiscal '98 from fiscal '97. (An estimated decline of 91 percent, to $0.27 per share, is expected in fiscal '98.)

Slow-moving inventory in the beginning of fiscal '98 hurt drive makers and resulted in lower earnings estimates for the year and low price-to-earnings and price-to-sales multiples. At press time, the stock was trading at 4.9 times earnings, but at 60 times fiscal '98 estimates and 14.7 times fiscal '99 estimates. Investors buying now are hopefully buying near a cyclical low, when the outlook is most bleak and the stock is at its least expensive point. Analysts had expected the company to earn more than $4 per share in fiscal '99 before lowering that estimate to $1.05 per share. Just as they were wrong on the upside in '97, they could be wrong on the downside now; in the meantime, the stock has already fallen 75 percent from its high of $54.75.

With the company trading at 0.3 times sales, the downside risk--a key component of investing--is limited, and the potential for an upside surprise exists.

At A Glance

Name: Western Digital Corp.
Recent price: $15.75
Price/earnings ratio: 5.0
Market: NYSE
Symbol: WDC

Figures are as of January 15, 1998

The Outlook

Past and projected sales and earnings

Fiscal Year: 1996
Revenues ($M):
$2,865
Net Income ($M): $96
Earnings per share: $1.00

Fiscal Year: 1997
Revenues ($M):
$4,177
Net Income ($M): $267
Earnings per share: $2.85

Fiscal Year: 1998 (estimated)
Revenues ($M):
N/A
Net Income ($M): $25
Earnings per share: $0.27

Fiscal Year: 1999 (estimated)
Revenues ($M):
N/A
Net Income ($M): $98.7
Earnings per share: $1.05

The Motley Fool can be found on the Web at http://www.fool.com and on AOL at keyword: FOOL. Jeff Fischer contributed to this article. The above opinions are those of the authors and not of Entrepreneur. Past performance is no guarantee of future results.