The theme of artificial intelligence (AI) has led to various areas of the stock market gaining value over the past year. However, it hasn’t just been concentrated to Nvidia and other giants.
Instead, other indirect beneficiaries have seen large share price movements as they ride on the coattails. Here’s one that’s caught my eye.
The story so far
I’m talking about Western Digital (NASDAQ:WDC). The stock’s up 577% in the past year, meaning £742 invested would currently be worth £5,023! That’s quite a return over the time period in question!
Usually, that would have me wondering whether all the good news was already priced in. But there’s a fundamental reason behind the surge, namely that AI needs an enormous amount of storage.
Western Digital primarily focuses on hard disk drives (HDDs). That might sound like yesterday’s technology, but high-capacity HDDs are critical for data centres because they provide huge amounts of storage at relatively low cost.
So with the surge in demand from AI for data centres for things like training models and creating AI-generated data, it all increases storage requirements. The result has been a powerful combination of higher volumes, stronger pricing and expanding margins.
The latest numbers illustrate this nicely. Fiscal fourth-quarter revenue jumped 44% year on year to £2.77bn, while adjusted earnings reached £2.64 per share. Management expects the momentum to continue, guiding for around £3.04bn of revenue next quarter.
The outlook from here
As with any huge move, there’s always some investor worry that they could be buying at the top. Of course, I can’t say for certain that the stock will keep rallying, but there are signs that indicate to me that the party isn’t over.
For a start, the business is pushing towards higher-capacity drives, where economics are considerably more attractive. Continued hyperscaler investment should keep supply tight and support pricing, while rising earnings mean the valuation can become cheaper surprisingly quickly even without the share price falling.
I also saw rival Seagate reported quarterly results at the end of July, showing 48% quarterly revenue growth and record annual free cash flow. So the wider industry’s results support the demand argument too.
Being sensible
However, after a 577% rally, expectations are hardly sitting on the floor. When the company released results last quarter, it beat revenue forecasts but the shares suffered a sharp sell-off. This shows the bar is now very high to impress investors, which is a risk because it can make it almost impossible for a positive suprise.
There’s also the point that storage remains cyclical, and today’s attractive pricing environment won’t necessarily last forever. This would be esepcially true if we see a slowdown in hyperscaler capex.
After weighing it all up, I’m still considering investing, but with a small amount to manage my risk. Investors with a similar viewpoint could consider the stock too.
Should you invest £5,000 in Western Digital right now?
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Jon Smith does not hold any positions in the companies mentioned.
This story originally appeared on Motley Fool
