As more and more of the world has moved online, data storage has become critical, and shares in Seagate Technology (NASDAQ:), which provides electronic data storage technology and solutions, has benefited from that.

The stock of the storage giant more than doubled from Oct. 30, 2020 (closing price of $47.82) to May 17, 2021 (closing price of $104.23).

However, since reaching the YTD high in mid-May, the shares declined 20.8% up to the FY Q4 2021 on July 21, 2021. STX closed at $82.60 on July 21, just slightly higher than the current price, even though the Q4 EPS exceeded the consensus EPS by 6%.

Going forward, the company’s growth market is enterprise-scale hard drives for the cloud, offsetting shrinking PC and consumer technology business lines. Cloud storage and data analytics platforms depend on mass-scale hard drives, providing Seagate with expanding market demand.

Seagate is also seeing growing demand for cryptocurrency storage solutions, although this is, so far, a small revenue source.

Source: Investing.com

The consensus outlook for 3-5 year EPS growth is 15.3% per year, which is in line with the Information Technology sector. The market has priced in higher earnings growth related to cloud applications, as evidenced by huge gains in the share price over the past year. The recent declines suggest concern that the rally was overdone.

Seagate has used share buybacks to reward shareholders, repurchasing 13% of outstanding common shares (slide 4 in the PowerPoint) in FY 2021. The buybacks, combined with the 3.3% dividend yield, are a substantial component of total return.

I rely on two forms of consensus outlooks in evaluating a stock. The first is the well-known Wall Street analyst consensus rating and price target. The second, the market-implied outlook, represents the consensus view of buyers and sellers of options. The market price of an option represents the market’s consensus estimate of the probability that the underlying stock will rise above (call option) or fall below (put option) a specific level (the strike price) between now and when the option expires. By analyzing the price of calls and puts at a range of strikes, all with a common expiration date, it is possible to calculate a probabilistic forecast for the share price that reconciles all of the options prices. This is the market-implied outlook. For background on this approach, including links to relevant financial literature, see this overview post.

As STX approaches its FY Q1 2022 earnings report on Oct. 22, I have calculated the market-implied outlook and compared the view from the options market to the analyst consensus outlook.

Wall Street Consensus Outlook for STX

ETrade calculates the Wall Street consensus outlook using the views of 12 ranked analysts who have published ratings and price targets within the past 90 days. The consensus rating for STX is bullish and the consensus 12-month price target is $100.40, 23.5% above the current share price.

Source: ETrade

Investing.com combines the views of 26 analysts in calculating the Wall Street consensus outlook. The consensus rating is bullish and the consensus 12-month price target, $98.36, is 21% above the current share price.

Source: Investing.com

In both the ETrade and Investing.com results, the consensus 12-month price target is slightly below the YTD high close for STX, $104.23 on May 17, 2021. The expected 12-month total returns (including the 3.27% forward dividend yield) from the ETrade and Investing.com price targets are 26.8% and 24.3%, respectively.

Market-Implied Outlook for STX

I have calculated the market-implied outlook for the next 3.1 months by analysing the prices of call and put options expiring on Jan 21, 2022 at a range of strike prices. I have also calculated the 4.9-month market-implied outlook using prices of options that expire on Mar. 18, 2022.

While there is decent option trading volume for the January options, trading is thin for the March options so the 4.9-month outlook should be viewed as less meaningful.

The standard presentation of the market-implied outlook is a probability distribution of price return, with probability on the vertical axis and return on the horizontal.

STX Market-Implied Price Return Probabilities From Now Until Jan. 21, 2022

STX Market-Implied Price Return Probabilities From Now Until Jan. 21, 2022

Source: Author’s calculations using options quotes from ETrade

The market-implied outlook for the next several months is generally symmetric between positive and negative returns. There is not a well-defined peak in probability or, to be more specific, there are two small peaks which correspond to price returns of +1.25% and -6.25%. The annualized volatility derived from this distribution is 36%.

To make it easier to directly compare the probabilities of positive and negative returns, I rotate the negative return side of the distribution about the vertical axis (see chart below).

STX Market-Implied Price Return Probabilities From Now Until Jan. 21, 2022

STX Market-Implied Price Return Probabilities From Now Until Jan. 21, 2022

Source: Author’s calculations using options quotes from ETrade. The negative return side of the distribution has been rotated about the vertical axis.

This view shows that the probabilities of large negative returns and large positive returns are very similar (the dashed red line and the solid blue line are almost on top of one another for returns from about 14% and higher in the chart above). The estimated probabilities of a range of returns from +/-5% to +/-13% (from 5% to 13% in return on the chart above) exhibit a tilt that favors negative returns. The probabilities of relatively low-magnitude returns favor negative returns, but the probabilities of high-magnitude returns are comparable.

Theoretically, we expect market-implied outlooks to have a negative bias because investors, in aggregate, are assumed to be risk averse and, as a result, tend to overpay for put options (which limit losses). Therefore having equal market-implied probabilities of positive and negative returns is a slightly bullish signal.

I interpret the market-implied outlook for the next 3 months to be generally neutral, slightly favoring small price declines.

The market-implied outlook for the 4.9-month period from now until Mar. 18, 2022 is consistent with the 3-month outlook. The annualized volatility derived from this distribution is 37%.

STX Market-Implied Price Return Probabilities From Now Until Mar.18, 2022

STX Market-Implied Price Return Probabilities From Now Until Mar.18, 2022

Source: Author’s calculations using options quotes from ETrade. The negative return side of the distribution has been rotated about the vertical axis.

Overall, the market-implied outlook to early 2022 is neutral, with slightly elevated probabilities of negative returns. The probabilities of large-magnitude positive and negative returns are very close.

The expected annualized volatility, about 36%, is quite high for an individual stock. There is an estimated 1-in-5 probability of having a price return of at least +17% and an equal probability of having a price return of -18% or worse over the next 4.9 months.

Summary

Seagate has enjoyed a substantial rally over the past year, as the market has grasped the potential demand for large hard drives for cloud applications. The shares are currently down more than 20% from the YTD high, even though management has signaled a robust outlook and EPS has been beating expectations.

The consensus of Wall Street analysts is bullish and the 12-month consensus price target implies expected total return of about 25.5%. The market-implied outlook to the first quarter of 2022 is neutral, with a slight bearish tilt and expected volatility of about 36%. As a rule of thumb for a buy, I want to see an expected 12-month return that is at least half of expected volatility.

The Wall Street consensus expected total return well above this cutoff. Given the reasonable valuation (forward P/E of 9.8) relative to the higher-margin cloud data storage and analytics business, along with consideration of the bullish Wall Street consensus and the neutral market-implied outlook, I’m assigning a bullish rating on STX.

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