SanDisk's Expectations Running Too High

 | Jan 21, 2014 | 5:30 PM EST
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SanDisk (SNDK) has been on a tear, rising more than 35% since the end of September. It is not alone in the semiconductor business either. Micron (MU), Seagate (STX) and Western Digital (WDC) also had stellar years last year as both demand and pricing improved.

SanDisk's performance is hardly surprising; it has beaten expectations in the last four quarters. As it has done so, analysts have struggled to keep up, revising estimates upward until the fourth quarter is expected to show a 50% improvement on last year.

Let me be clear that in the medium to long term, I believe that SanDisk, because of its focus on the now rapidly expanding flash market and the potential for its enterprise solid-state drives, is a buy. In the immediate future, however, I would not buy, and if you are already long, I would consider taking some profit. Expectations are now at such a level that anything that can be construed as a negative, either in the report or subsequent call, could result in an exaggerated downward move.

I bang on about this all of the time. In markets, reality must be measured against expectations and perceptions. When good news is piled upon good, as has happened with SanDisk, the expectation of that continuing ad infinitum is quickly priced in, and anything that threatens that outcome is perceived as a disaster.

Thus, should SanDisk merely match the expected earnings figure or even, God forbid, miss by a penny or two, plenty of longs with itchy trigger fingers will push the price down as the week draws to a close. Similarly, even if there is a modest beat, any hint by management that exponential growth may not continue forever would likely be met by a wave of selling.

Both of these things are possible. The NAND flash memory that is the core of SanDisk's business is a commoditized product, and according to this Digitimes report from earlier today, prices fell in the first half of January and look set to continue to fall for the rest of the month. There is nothing new about this for SanDisk or for any memory manufacturer, but given those exaggerated expectations, we are already seeing a reaction as I write. SanDisk has lost more than 3% so far in a market that is generally slightly positive. Imagine the effect if management cites those lower prices and predicts lower OEM demand in slightly more cautious guidance for 2014.

SNDK, 12 Months

As I said, I am actually fairly bullish on SanDisk over the long term, but I'll be watching closely over the next couple of days. Good results are expected, so they would have to be exceptional to move the needle, and anything bad could lead to a rapid return to the $65 level that was last seen before the third-quarter earnings release. At those levels, SanDisk would be a screaming buy to me, and given the situation, you would seem to be risking little by waiting.

Expectations and perceptions matter. In many cases, they are the most important factors in short-term moves. This helps to explain some of those moves that mystify newcomers to the market, for example when a company's earnings match estimates and it gives a fairly upbeat forecast, but the stock falls. This could well happen when SanDisk reports tomorrow. But even if not, any upward move is likely to be muted. If you agree that SanDisk is a decent long-term investment but believe that there seems to be little to gain from buying now, you could find yourself in the ironic situation of looking for bad news from a company that you like.



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