Western Digital’s Earnings Will Test Whether Its AI Rally Has More Room

Key Points

• Western Digital shares have fallen about 40% from June's peak, though the stock remains up significantly for the year ahead of its Aug. 5 earnings report.
• Analysts including Morgan Stanley and Citigroup remain bullish, with price targets of $650 and $800 respectively, giving the stock a consensus Moderate Buy rating.
• The earnings report will hinge on gross margin trends and supply-demand commentary, while the stock's continued premium valuation leaves little room for disappointment.

Few stocks capture the euphoria and the anxiety of the artificial intelligence (AI) storage boom quite like Western Digital Corporation NASDAQ: WDC. Through the middle of last month, the stock had been one of the market's standout performers of the year, riding relentless demand for data storage to enormous gains. Yet the past few weeks have been a sharp reminder that nothing goes up in a straight line.

Shares have fallen around 40% from June’s high as the wider AI trade has wobbled, with investors growing nervous that elevated valuations across the storage and memory space may have run ahead of themselves. However, even after that drop, Western Digital shares are still up significantly for the year to date, which rather neatly frames the question facing investors today.

With the company due to report earnings on Aug. 5, is this pullback a chance to buy one of the AI theme's biggest winners at a discount, or a warning that the storage rally is finally running out of road?

Western Digital’s Bull Case Still Starts With AI Storage Demand

Let’s start with why the stock ran so hard in the first place. Western Digital sits at the heart of one of the most powerful supply-and-demand imbalances in tech right now. The explosion of AI infrastructure has sent demand for high-capacity storage soaring, while supply has remained tight, handing manufacturers like Western Digital significant pricing power.

That dynamic has been showing up throughout the business. Revenue has been growing rapidly year over year, while the company has generated enough cash to hike its dividend and buy back a meaningful chunk of stock.

Wall Street Has Not Given Up on the AI Storage Trade

The analyst community has clearly taken note, with Morgan Stanley recently raising its price target to $650, arguing that conservative margin guidance leaves ample room for another beat. Alongside Citigroup’s refreshed price target of $800 from earlier this month, and the nearly 40% that implies, it’s easy to see why Western Digital has a consensus rating of Moderate Buy.

Crucially, the tailwinds driving these bullish updates all look durable. Data center capital spending is projected to keep climbing for years to come, driven by the same AI buildout that has powered the storage rally so far. The thinking is that if this demand holds, Western Digital's pricing power should hold with it.

Earnings Will Test the Margin Story

That makes the upcoming earnings report an important test. The single most-watched number will be gross margin, which has become the clearest signal of whether the company's pricing power is still expanding.

Management has guided to a healthy gross margin, and any sign it is coming in ahead of that, or being guided higher still, would go a long way toward confirming the bull case. Continued expansion would tell investors that the tight-supply story remains intact and that the recent sell-off was little more than sentiment-driven noise. On the other hand, a softer read would give the bears exactly the ammunition they have been looking for.

Beyond margins, investors will also be listening closely to what management says about pricing and supply heading into the back half of the year. In a story built almost entirely on the supply-demand imbalance, any hint that the imbalance is starting to ease would matter far more than the headline revenue and earnings figures.

Valuation Still Leaves Little Room for Error

For all the strength in the underlying dynamics, the bears have some legitimate points, and none is stronger than Western Digital’s valuation. Even after the recent pullback, the stock still trades at a meaningful premium to both its own historical averages and its sector peers.

When a stock goes into an earnings report still priced so richly, the room for error is minuscule, and any disappointment, even if the results themselves are still solid, can be punished quickly.

Investors Have to Decide How Much Risk to Take Before Earnings

This is where it’s hard to ignore the risk/reward profile after such a sell-off, especially as the analyst community has remained so bullish, with targets rising even as the stock has fallen in recent weeks.

If the demand proves as durable as the bulls believe, a 40% pre-earnings pullback could end up looking like a golden entry opportunity in hindsight. For investors who believe the AI buildout is still in its early innings, buying quality on weakness has tended to pay off throughout this cycle, and it could be a smart move to consider again now.