Stock Up on Storage

Last month I showed how investors can generate investment ideas by using the Producer Price Index (PPI) report prepared monthly by the Bureau of Labor Statistics. The idea is that industries in which prices are rising may contain companies where revenue will grow faster and/or margins will improve.

Of course, this is only a starting point. It is useful to generate ideas, but further research is needed to determine whether they are good ideas. This month, I do some of that further research, looking into the technology sector -- specifically, computer storage.

In the technology sector, prices almost never go up. But sometimes they decline at a slower rate than normal, which tends to have the same effect on sales growth and profit margins.

A month ago, the year-over-year price declines for computer-storage devices were the lowest they had ever been. Although pricing ticked down in September from that level, it is still one of the strongest readings on record.

Naming Names

There are plenty of ways to play this one, including Brocade (BRCD - commentary - Cramer's Take), EMC (EMC - commentary - Cramer's Take) or Iomega (IOM - commentary - Cramer's Take).

Several other names of interest would be Hutchinson (HTCH - commentary - Cramer's Take), Quantum (QTM - commentary - Cramer's Take), SanDisk (SNDK - commentary - Cramer's Take), Seagate (STX - commentary - Cramer's Take) and Western Digital (WDC - commentary - Cramer's Take). It will require a closer look to see which ones seem like the best bets.

Brocade beat earnings estimates last quarter, and although it said the industry remains competitive, the competition didn't seem to be hurting pricing. On its conference call, Brocade noted that, "From a pricing perspective, the pricing environment for the past several quarters has been more favorable than historical levels. While we believe ASP declines may eventually return to mid-single-digits per quarter, as competitors ramp their new product offerings, our current outlook is for a relatively benign pricing environment in [the fourth quarter] , with ASP declines once again in the low single-digits."

The competitive environment for storage continues to be mitigated by consolidation. Brocade bought McData, Seagate bought Maxtor and EVault, and Quantum's purchase of Advanced Digital Information has since been followed by the Western Digital/Komag merger.

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At the time of publication, Trent had no positions in the stocks mentioned, although positions may change at any time.

William A. Trent, CFA, is a freelance equity analyst based in the New York metro area. He has been an equity analyst since 1996 and is co-author of Understanding and Evaluating Prospectuses, Offering Documents, and Proxy Statements. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Trent appreciates your feedback; click here to send him an email.