It wasn’t long ago that investors couldn’t run away from Western Digital (WDC) fast enough. The darling of contrarian tech investors only two years ago as its share price soared above $100, rapidly declining sales of PCs during the past year and concerns over the price Western Digital paid to acquire SanDisk dragged the stock below $40 as recently as this May. That struck me as excessive given WDC’s large presence in cloud storage and SanDisk’s leadership position in the fast growing SSD (solid state drive) market, so I recommended it to our readers in the May 26 edition of Breakthrough Tech Profits.

Turns out my timing was pretty good; since closing at $44.38 that day the share price of WDC has quickly moved almost 20% higher, opening above $52 this morning. I also suggested buying a LEAPS option on WDC to goose your gain, a position we closed out last Friday for a net profit of better than 50% in less than two months! Who says you can’t make big money in old tech stocks anymore?

But with that options play now closed out our attention focuses once again to what is a fair price to pay for WDC stock now that it is priced at $52 instead of $44, and to what extent investors may once again be following a herd mentality to an unsustainable conclusion. Any time a stock makes a move of that magnitude in such a short period of time, we must ask ourselves two questions; (1) why do so many more people want to own the stock now, and (2) has the stock become overvalued?

The first question is usually relatively easy to answer. In almost every case when the price of a stock rises quickly it is because new information has become known that changes one or more of the critical input values that analysts use to calculate an enterprise value for the company. In the case of WDC that new information was exactly what we thought it would be when we wrote about it two months ago; namely, just how soon its acquisition of SanDisk would begin impacting the bottom line.

On July 6^th Western Digital released revised guidance indicating that its fiscal fourth quarter revenue is likely to be higher than originally projected (the company is scheduled to release those results on July 28^th). That suggests it has been able to digest the SanDisk acquisition quicker than anticipated, in which case it’s not just fourth quarter revenues that will be higher but every quarter thereafter, too. That is why several analysts have revised their earnings estimates for WDC upward since that revelation, which in turn has caused them to raise their target price for its stock.

Answering the second question – is the stock now fairly priced? – is much more difficult since it necessarily requires a number of assumptions regarding future outcomes that are not yet known. For that reason we employ a proprietary formula to determine the fair value of every large-cap tech stock. I’ll explain my IDEAL Stock Rating System in this Thursday’s edition of Breakthrough Tech Profits, but for now suffice to say that according to my system Western Digital is still undervalued by about 20%.

To be clear, that does not necessarily mean that the share price of WDC will race another 20% higher as soon as the quarterly earnings report hits the street.  But it does mean that investors have not yet gone overboard buying WDC, so downside risk is minimal. In the opening sentence of my May 26^th article I stated, “disk drive maker Western Digital’s stock is oversold, and we think it could rise 30% within the next year and a half.” Now that more than half of that gain has been captured in only seven weeks, we do not recommend aggressively purchasing WDC until there is greater clarity concerning the pace at which future earnings will benefit from the SanDisk acquisition.