Seagate and Western Digital: One Number Says It All

Western Digital and Seagate Technology traded considerably lower on Tuesday after the latter reported disappointing earnings. While there were strengths and positives to Seagate's report, there was one number that really stood out, giving investors a clear indication of whether to buy or sell.

Two clear market leaders
Despite a rather large sell-off in Seagate shares, the stock still trades with two-year gains of 180%, outperforming Western Digital's 130% return.

Combined, the two companies control about 85% of the hard-disk drive, or HDD, market. Recently, both companies have made large investments into solid state drives, or SSDs, which are used in tablets and smartphones, but carry much lower margins than HDDs.

Nonetheless, these market leaders have performed well, despite rapid decline in PC and tablet sales, by strategically investing and capitalizing on new markets in the cloud and lessening their dependence on the PC/laptop market.

A single leader emerges
For the most part, Seagate and Western Digital have performed the same for the last two years, trading with similar fundamentals and market caps during this period. Yet, over the last year, a leader has emerged, which is even more evident when comparing the companies' earning reports.

For the last year, we have seen a growing disconnect in the market share of these two companies. In the December quarter, both Western and Seagate estimated their total addressable market for hard drives at 142 million units. Notably, this is up about six million units year-over-year.

However, Seagate estimates its market share at 40%; in the same quarter, Western estimates a 45% market share for its business.

Why is this such a big deal?
A 5% gap between these two peers may not seem like much, but at this time last year, both companies had a 43% market share. Since then, Western Digital's share has increased 2%, while Seagate's has fallen 3%. Furthermore, this isn't just a single quarter occurrence, as the growing gap has been progressing over the last few quarters.

In July, Seagate's share was 41% and Western's was 44.4%. Clearly, this trend has continued into the most recent quarter, and it can be seen clearly in each company's sales performance.

Western Digital saw revenue growth of 4.7% last quarter, while Seagate's declined 3.8%. Obviously, if you're operating in an industry with modest growth, and you're losing market share, then revenue losses will be the result, as seen with Seagate. Conversely, if you gain market share, your revenue will rise, which we've seen with Western Digital.

Where to invest?
As stated, these are two very similarly valued companies; both trade at 1.3 times sales, but are fundamentally moving in opposite directions.

Western Digital is growing and has some room to improve its operating margin of 13%. Seagate is clearly not growing and has seen a consistent trend of margin declines in recent quarters. In particular, Seagate has seen its gross margin fall from the mid-30% range in late 2012 to the current 28% level. While one reason is a higher mix of low-margin storage devices, its lack of growth isn't helping profitability, either.

It seems reasonable that if you're willing to invest in this space, Western Digital would be more deserving of a premium over Seagate. Simply put, Western Digital has proven over a one-year period that its growth is not a fluke, but rather a consistency that's been created from better execution in the marketplace.

What about other storage investments?
While Western may be the better investment, a debate surrounding whether other storage segments present more upside has also been discussed.

In particular, many investors have favored EMC Corporation . The company is primarily engaged in cloud virtualization, but offers storage solutions aimed at data centers and computing applications.

EMC works with large corporations in communications, energy, financial, retail, and most other major segments of the market. Therefore, it has operated with consistent growth over the last four years, and has operating margins of 18.4%, significantly higher than traditional HDD companies.

However, EMC faces a significant threat from cloud service providers that build their own storage systems. Corporations switching to cloud service providers might indirectly benefit the HDD/SSD business, as those systems store data on such products, while directly negatively impacting EMC.

Final thoughts
With an 85% market share, Seagate and Western Digital are their own biggest threat. On the other hand, EMC faces a slew of competitors, from both cloud service providers and the likes of Oracle and IBM. Therefore, predicting long-term performance for EMC is challenging.

With Seagate and Western Digital, the latter has proven its dominance in the industry by stealing market share from its competitor. The fact that these two companies were neck-and-neck with market share 12 months ago, and Western Digital now has a 5% advantage, is an incredible feat.

To invest in this space, the best choice is clearly Western Digital.

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The article Seagate and Western Digital: One Number Says It All originally appeared on Fool.com.

Brian Nichols has no position in any stocks mentioned. The Motley Fool owns shares of EMC and Western Digital.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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