Thursday's Top Upgrades (and Downgrades)

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This series looks at which upgrades and downgrades make sense and which ones investors should act on. Today, we're surveying the automotive world, as Wall Street sharpens its pencils and marks up the prospects at Penske Auto Group (NYS: PAG) , AutoNation (NYS: AN) , and O'Reilly Automotive (NAS: ORLY) . Gentlemen, and -women, start your engines!

... and now turn them off? Seriously?
It's not often you see a company report an earnings beat, and then immediately get hit with a downgrade, but that's just the sad fate that met investors in Penske Automotive Group this morning. Yesterday, Penske reported earning a $0.55-per-share profit in Q1 2012, a full $0.09 better than had been expected. Regardless, the news netted Penske a downgrade to "hold" from the analysts at KeyBanc.

This makes no sense. In the short term, beating earnings by nearly 20% is certainly good news. And according to KeyBanc, Penske has every chance of doing well in the long term as well, buoyed by strong light-vehicle buying in the U.S., decent prospects in the U.K. as well, and improvement in its own profit margins. Regardless, KeyBanc says it's concerned about the valuation.


It shouldn't be. At $2.4 billion in market cap, Penske today costs less than 13 times trailing earnings. KeyBanc itself says forward prospects look good -- perhaps good enough to achieve the 18% long-term growth that Wall Street projects for it. Between the low P/E ratio, the high rate of expected growth, and the fact that Penske just proved its ability to meet or exceed expectations, this stock looks a whole lot prettier than KeyBanc gives it credit for. Downgrade or no downgrade, Penske could go far.

Coming in second ...
Next up in pole position this morning is Penske rival AutoNation. Like Penske, the nation's biggest car dealer by revenues just reported earnings (coincidentally, also $0.55 per share). Unlike Penske, AutoNation is getting rewarded for its "beat" -- with an upgrade from UBS.

Yet while KeyBanc says valuation makes Penske a hold, and UBS is upgrading AutoNation to "hold" as well, the numbers argue nearly as strongly in favor of buying AutoNation as Penske itself. Here we're got a stock selling for 17 times earnings (a bit more than Penske) but pegged for nearly 20% growth on Wall Street (a bit faster than Penske, justifying the higher P/E ratio).

Conclusion: Penske's lower price and the fact that it pays a dividend suggest that one's the more likely winner in a two-car-salesman race. But AutoNation runs a pretty close second. Give 'em a look, "two."

Pit stop
Finally, we shift gears from the world of car selling to the world of car repairing ... and car-parts retailer O'Reilly Automotive. Strong Q1 sales and earnings sent the shares soaring this morning, and adding a turbocharge to the engine is an improved price target out of -- you guessed it -- UBS.

As with Penske and AutoNation, this stock too deserves your attention, although the story's a bit more complex than with the car dealers. You see, at 27 times trailing earnings, O'Reilly actually looks a bit overpriced relative to projected growth rates of just 17% over the next five years. To see why these are good numbers, though, you need to look past reported GAAP earnings and see what's happening on O'Reilly's cash flow statement. It's there you see that at the same time as O'Reilly was claiming just $553 million in trailing earnings, its actual free cash flow for the past year has been nearly twice as strong -- $930 million.

What this means is that the stock everyone else sees as costing "23 times earnings" actually costs only about 14 times the amount of cash it generates in a year. And that's plenty cheap for a 17% grower like O'Reilly.

Long story short, all three of these companies look quite attractive. In order of buy-ability, though, they're basically as laid out above: Penske first, AutoNation second, and O'Reilly a strong contender for third place in your portfolio.

Fool contributorRich Smithholds no position in any company mentioned. His reservations aside, though, The Motley Fool does own shares of Panera Bread, andMotley Fool newsletter serviceshave recommended buying shares of Panera Bread and McDonald's. The Motley Fool has a disclosure policy.

At the time this article was published

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