This column was originally published on RealMoney on Feb. 10 at 1:07 p.m. EST. It's being republished as a bonus for TheStreet.com readers.
It used to be that disk drives were only in computers. Today they turn up in MP3 players, cameras, TiVos and DVD recorders. In the near future, expect to see them in your cell phone and auto. That sounds great for disk-drive makers, but it's a market with a few major buyers, making the pricing pressures on disk-drive manufacturers intense.
As a result, the number of disk-drive manufacturers has dwindled over the years. One of the survivors is
. Seagate, the largest independent disk-drive maker, announced in late December that it would purchase the second-largest independent, Maxtor.
Through all the changes in the technology industry, Seagate has proven itself a nimble adaptor. It is a technological innovator, with an R&D budget far in excess of anyone else's. It is dominant in its industry, and it has a management team that has proven it can roll with the punches in a constantly evolving marketplace.
Two of the guru strategies I follow indicate that Seagate should continue to drive rings around its competition.
The David Dreman Strategy
Dreman's approach, which is the best-known contrarian strategy on Wall Street, considers only the largest 1,500 companies.
Seagate's reported earnings for the most recent quarters have a rising trend. Seagate's EPS growth rate over the past six months has been 3.6%, easily beating that of the
, which dropped 0.48%. It probably will continue to beat the market average: Its estimated EPS growth for the current year is 56.7%.
Under my Dreman strategy, a stock must pass two of four tests to be labeled contrarian. Seagate's P/E of 11.8 is in the bottom 20% of the market, as is its price-to-cash-flow ratio, which puts it over the hump. Seagate fails the two other contrarian tests -- neither its price-dividend ratio nor its price-to-book ratio is in the bottom 20% of the market.
To demonstrate financial strength, prospective investments should have a current ratio equal to or greater than the average of its industry, a dividend payout ratio below that of its historical payout ratio (this indicates the company can raise its dividend, if it wants to) and a return on equity greater than the ROE of the top third of the 1,500 largest-cap stocks. Seagate passes all of these tests. Its ROE, 41.4%, is exceptional; anything north of 27% is staggering, by this strategy. In addition, Seagate's pretax profit margins are12.8%, well above the strategy's benchmark of 8%.
The Peter Lynch Strategy
My strategy based on Peter Lynch's investing style favors companies with several years of fast earnings growth, as these companies have a proven formula for growth that in many cases can continue for many more years. This methodology likes to see earnings growth in the range of 20% to 50% (earnings growth over 50% may be unsustainable). Seagate's growth rate is 28.9%, based on the average of its three- and five-year EPS growth rates. It earns the Lynchian label of "fast grower."
With a P/E of 11.8 and a growth rate of 28.9%, Seagate's P/E/G ratio (P/E relative to the growth rate) is a stellar 0.41. A P/E/G of less than 0.5 is considered top-notch.
When inventories increase faster than sales, it is a red flag. However, Seagate's inventory to sales has fallen from 7.2% last year to 5.7% this year.
Equity should be three to 10 times debt. Its equity is about eight times debt, indicating that the company has relatively low debt.
Seagate is a proven survivor, a proven technological innovator and a well-run company. I expect its stock to increase its price capacity, much like the way the company has increased its disk drives' storage capacity.
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John P. Reese is founder and CEO of Validea.com, an investment research firm, and Validea Capital Management, an asset management firm serving affluent investors and companies. He is also co-author of the best selling book,
The Market Gurus: Stock Investing Strategies You Can Use From Wall Street's Best
. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Reese appreciates your feedback.
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