The PC isn’t dead yet – here’s how to profit

Conventional wisdom says that the personal computer's days are numbered, as smartphones and tablets take over. But don't write the sector off just yet, says Matthew Partridge. Here, he explains how to profit.

The PC's time is over.

Smartphones and their bigger brothers, tablet computers, will put an end to clunky desktop computers. Even laptops will be a thing of the past.

At least, that's the theory. But we're not convinced.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

Androids and iPhones are great for checking email or Facebook on the run, and iPads are fantastic for reading e-books and making tweaks to existing documents and spreadsheets. So it makes sense that the number of PCs sold in the US is in decline.

But reports of the death of the PC' have been somewhat exaggerated. They still have an advantage in terms of speed and storage, and for many people, in convenience too.

And if people still want PCs, that means the companies that make PC hardware will profit too. Here's how you can take advantage.

Hard disk drives still have a future

Even analysts who used to be bearish on the PC, now think the product has a brighter future ahead of it.

Ranjit Atwal of Gartner expects developing market demand to continue to grow strongly, for example. "Emerging markets have very low PC penetration and, even with the availability of other devices, we still expect a steady uptake of PCs." Overall, he predicts that global sales will grow by 4% this year.

So how can you profit? One particular niche looks good value to us memory.

Desktops and tablets use different types of memory to store information. PCs generally use hard disk drives (HDD). These are cheap and have a very large capacity. However, they are bulky, use a lot of power and can crash.

Tablets on the other hand use solid-state drives (SDD). These are much lighter and less power intensive, but also much more expensive and with a smaller capacity.

Clearly, if PC sales remain solid, that should lead to more HDDs being sold than perhaps analysts expect. But the digital revolution is also creating new HDD markets. Consultants In-Stat note that: "as video has gone digital, demand for storage is found in consumer applications including set top boxes (STBs), external drives, automotive applications, personal media players, camcorders, home servers, and video cameras". As a result, by 2015, they expect the number of external HDDs to have doubled from 2010.

Profit margins in the industry should also benefit from consolidation. Recent mergers mean that the top two firms, Seagate Technology (Nasdaq: STX) and Western Digital (NYSE: WDC), each control 40% of the market. As a result Tom Coughlin and Ed Grochowski of Coughlin Associates think that prices and margins, which spiked after floods in Thailand hit supply, will not return to pre-flood levels until 2014 at the earliest.

Seagate has shot up but it still looks cheap

Shares in Seagate, which was not hit by the floods, have gone up by nearly 90% this year. And yet, the company still looks cheap. It is trading at seven times earnings and has a yield of 3.2%. Indeed, if you use this year's expected figures, its price/earnings (p/e) ratiofalls to below four. Robert Marcin of Defiance Asset Management thinks that even on normalised' profits it should be trading at $40 a share giving it roughly 30% upside from here.

The company also performs well on other metrics. It makes a 15% and 63% return on its assets and equity respectively. As my colleague Tim Bennett has pointed out, a high return on equity (ROE) suggests that a company is making efficient use of its capital. This should help it maintain a dividend while growing strongly.

Better yet, even if the HDD market does die out, Seagate should be safe. It has invested in developing high-end SSD technology. Its latest solid-state product, one of the fastest such drives on the market, was showcased this week at an industry fair, where it was warmly received.

An alternative is Seagate's main rival, Western Digital. Unlike Seagate, Western was badly hit by the Thai floods, which cut production in half at one point. However, successful recovery efforts and its purchase of Hitachi's storage business meant that last quarter's sales were the largest in the company's history. It has followed Seagate by investing in ultra-fast SSD, suggesting the two companies could recreate their duopoly.

Western Digital is not as cheap as Seagate. Its trailing p/e is 9.5, and it doesn't pay a dividend, which makes it the less attractive of the two. However, assuming it meets its earnings targets, the p/e falls to four. Western has risen by 30% this year, but we suspect the rally could go further.

Both companies look to be solid investments. Neither PCs nor HDDs are going away soon. And the concentrated market structure should also keep prices and therefore profit margins - high. If you only want to invest in one, we'd favour Seagate, but Western looks attractive too.

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

How advances in biotech could revolutionise your portfolio

An exciting new age of medical discoveries is dawning, says Jim Mellon. Here, he looks at the future of biotechnology, and picks the best 12 pharmaceutical stocks to buy now.

Three top investment tips from Keynes

It's a great shame that economist John Maynard Keynes is best known for his controversial stimulus policies, says Tim Bennett. Because he was also a brilliant investor.

Dr Matthew Partridge

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri