I have this investment formula that works. It's not that hard to understand, but it does take some courage to execute.

This formula dictates that individual stocks should be bought only when certain conditions are in place:

  • The stock has had a large price decline.
  • It trades at a compelling valuation.
  • It has decent fundamental news.

Clearly, the hard part is buying after a large price decline.

I've used this process successfully for more than 20 years. Many of the individual stock mentions I've made on this site have fit that model. In the past four years, many of them have been huge winners, and hopefully some readers have benefited from them.

That said, the process does not work all the time. After all, no method is foolproof. However, my mistakes have been quite modest compared to the victories. That's the other side of this discipline: When it's wrong, I usually don't get creamed. You won't encounter many Rackable Systems ( RACK) with this discipline.

After the relentless rally since last summer, my buy screen has dwindled, and I can't get stocks to fit the "down big" parameter. Yet, recently a decent quality tech stock hit my screen. As the cheapest tech stock on the planet, I think it merits a look.

The name of the company is Komag ( KOMG), and it's a leading independent supplier of media to the disk-drive industry.

At $34 per share, the stock trades for about 8 times earnings, 4.4 times pretax cash flow and 1.0 times revenue, and it provides a 13% free cash flow yield. One would have a hard time finding many tech stocks with cheaper valuations.

Not Without Challenges

Now this cheapness always comes with some issues, and Komag is no different. Analysts are trimming their earnings estimates as the company reverts to a more normal margin structure from last year's shortage-condition profits. Komag also has a concentrated customer base.

Finally, the company needs to transition its technology to emerging perpendicular recording disks, new customers and the rapidly growing notebook market. Komag contends it is well on its way to achieving all three.

Wall Street, having loved the stock at $54, now hates it at $34. Komag is the go-to "sell" stock in the most-underappreciated tech sector: hard-disk drives. For some reason, not a single sell-side analyst has even a buy on the hard-disk-drive sector. Despite strong, 15%-plus unit growth, healthy profitability and much better competitive dynamics after consolidating, the industry has few fans. I guess the nosebleed P/E multiples of 8 to 10 are scaring everyone away.

At current prices, Komag represents a very interesting idea. Should the company manage its transition gracefully and resume strong growth with no further margin compression, the stock could easily hit a new high within a year. However, should the business taper faster than I expect, a stock that's down almost 40% and trading at compelling valuations should offer some downside protection.

Part of the success of my process is the sell discipline. If Komag experiences a material decline in earnings, I will sell the stock immediately. By definition, it will no longer be a low-P/E stock.

But for now at least, the industry and the company are doing just fine. Take advantage of a panicky analyst community and an aggressive group of very loud shorts. They are providing one compelling buying opportunity for the cheapest tech stock in the world.

At the time of publication, Marcin was long Komag, although positions may change at any time.

Robert Marcin is the founder of Defiance Asset Management, a private investment management firm. Client accounts managed by Defiance Asset Management often buy and sell securities that are the subject of commentary by Marcin, both before and after it is posted. Under no circumstances does this column represent a recommendation to buy or sell stocks. This column is intended to provide insight into the financial services industry and is not a solicitation of any kind. Neither Marcin nor Defiance Asset Management can provide investment advice or respond to individual requests for recommendations. However, Marcin appreciates your feedback; click here to send him an email. Marcin is not required to update or held responsible for updating any portion of this column in response to events that may transpire subsequent to its original publication date.

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