How do you sell a stock that you own that has gone from all time highs in late 2014 ($70) to now trading at $42? And how do you even contemplate shorting a stock that has suffered that sort of decline? First you consider the history of the underlying stock’s peak to trough declines, and second, you make trades very carefully. The stock that I am talking about is Seagate Technology (STX) the maker of disk drives for computers and servers. From its 2008 lows to the recent highs, STX rose more than 2000%. And from late 2011, the stock rose in a very steady uptrend, up 650%:
The stock’s break below $60 on its way to $50 in February and March was the first successful breach of the uptrend that had been in place since late 2011. The stock’s recent break below $50 was essentially the last line of support rendering the chart a full on disaster.
Much like others in the PC supply chain, STX sells commoditized products that are subject to sharp cyclical turns. STX’s earnings market usually reflects the potential short sharp downturns, usually trading well below a market multiple, right now trading about 9x expected fiscal 2016 earnings. The company has an ok balance sheet with a fifth of their $12.5 billion market cap in cash ($2.5 billion) and $4.1 billion in debt. Back in April the company announced a new $2.5 billion share buyback, and they also pay a dividend that currently yields 5%. I suspect if PC sales were to get worse (shipments for the year are expected to decline 4.5% from 2014) then funding buybacks and dividends are likely to get a tad tougher. I would add that leading up to the financial crisis STX did cut their dividend and ultimately discontinue it from April 2009 to April 2011:
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From Bloomberg[/caption]
The takeaway is simple. Cyclical tech stocks that appear cheap can get much cheaper. STX had a peak to trough decline of 90% from late 2007 to early 2009, so the stock’s current 39% decline could be the midway point of a sell off if we were to see some worst case scenarios that include dramatic earnings and sales declines, capital return cuts and a bear market. Not saying any and all of that will happen, but history tells us that it could.
Some may look at a chart like this and see and easy entry at $40 playing for a bounce back to $50:
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STX 3 year chart from Bloomberg[/caption]
But it’s is all a matter of your world view and risk tolerance. We would be using these technical levels as a reasonable guide on entries and exit points. Longs may want to use $40 as a stop and from a technical perspective any break below that may set up for a press on the short side.