This Just In: More Upgrades and Downgrades

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At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." The pinstripe-and-wingtip crowd is entitled to its opinions, but we have some pretty sharp stock pickers down here on Main Street, too. And we're not always impressed with how Wall Street does its job.

So perhaps we shouldn't be giving virtual ink to "news" of analyst upgrades and downgrades. And we wouldn't -- if that were all we were doing. Fortunately, in "This Just In," we don't simply tell you what the analysts said. We also show you whether they know what they're talking about.

Talking donuts with Davidson
Dunkin' Brands
(NAS: DNKN) shareholders, prepare yourself for a head-fake. Prepare yourself for heartbreak. On Friday, the equities analysts at DA Davidson initiated coverage of Dunkin' with the following kind words, as relayed by StreetInsider.com:

Dunkin' Donuts U.S. is the key to the story and positioned for continued success. The brand has grown sales productivity through effective product development, merchandising, and marketing. Comp store momentum should continue with the benefit of the K-cup rollout, which we estimate will add 4% to comps through 2013.

And then they told investors to sell the stock.

According to Davidson, you see, Dunkin' Donuts may (or may not) make the world's best coffee. It may (or may not) be a viable contender to McDonald's (NYS: MCD) and Starbucks (NAS: SBUX) in the coffee wars. It may be poised for decades of growth and profits, kickstarted by a jolt of Green Mountain Coffee Roasters' (NAS: GMCR) K-cup goodness. About one thing, though, there can be no doubt: "Despite an attractive long-term growth opportunity, we cannot justify the current valuation. We are skeptical that the potential benefits from brand popularity and the excitement surrounding the IPO can be sustained."

Time to break the donuts
Sadly, I'm forced to agree with DA Davidson on this one. I mean, there's no bigger fan of Dunkin' Donuts brand coffee than yours Fool-y. But facts is facts, Fools -- and the plain, unglazed fact of the matter is that Dunkin' costs too much.

I'm not even talking about the company's P/E ratio, either. Anybody can look at Dunkin's $19 million trailing net income and tell you this stock shouldn't be fetching 175 times earnings. Me, I look past the headline numbers and give this firm the benefit of every doubt, valuing it on real cash profits instead of accounting "net income" -- and Dunkin' still comes up short.

Dunkin' boasts $3.2 billion in market cap at last report. Based on trailing free cash flow of $201 million, this works out to a 16 price-to-free cash flow ratio -- already somewhat expensive in light of consensus predictions of 15% long-term growth. But Dunkin' also has $1.7 billion in net debt, which, when added to market cap, results in an enterprise value of $5 billion. Valued on EV/FCF, the stock's even more expensive at a 25 ratio.

Foolish takeaway
To justify this valuation, I'd have to assume pretty outrageous growth for Dunkin' -- more than twice the 9% average projection on the Dow Jones Industrial Average (INDEX: ^DJI). Faster growth even than the estimates Davidson suggests are been inflated by "brand popularity and the excitement surrounding the IPO." I'd have to accept the immediate 4% K-cup bump in "comps" that Davidson projects, assume it won't be a one-time thing, but will keep adding to growth in years to come ... and the stock still falls short of the mid-20s growth rate I'd need to justify this stock price.

Long story short? Any way I look at it, Dunkin' costs too much. And Davidson is right to recommend selling it.

Can Dunkin' Brands prove the skeptics wrong?Add it to your Fool Watchlistand find out.

At the time this article was published Fool contributorRich Smithdoes not own (or short) shares of any company named above. You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 276 out of more than 180,000 members.The Motley Fool owns shares of Starbucks.Motley Fool newsletter serviceshave recommended buying shares of Green Mountain Coffee Roasters, McDonald's, and Starbucks.Motley Fool newsletter serviceshave recommended creating a lurking gator position (yes, that's seriously what they call it) in Green Mountain Coffee Roasters.We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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