Friday's Top Upgrades (and Downgrades)

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This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, most analysts appear to be sleeping in after the holiday, but there still are a few ratings changes to report. We'll be looking, in particular, at two upgrades in the telecom sector -- Ericsson and Telecom Italia . But let's take a quick trip to China to check out...

A downgrade for Renren
The month is ending on a sour note for investors in "Chinese Facebook" company Renren , as the stock is dropped from hold to underperform at Jefferies. Warning that "game revenue declined 16.9% YoY" at Renren, with "existing games reaching maturity coupled with delay in new game launch," Jefferies says that it sees little chance of immediate improvement in the company's gaming revenues. In particular, Jefferies worries that Renren will face increasing competition "from Tencent and others with strong mobile game distribution platforms." notes that Jefferies seems particularly worried about "adoption and monetization" of Renren's products, fearing that the company is losing market share to competing products. The analyst's lowering of its price target 12%, to $2.90 per share, is having an immediate effect on the stock, as Renren plunges this morning to within just pennies of that new price target.

Isn't Jefferies being too pessimistic, though? I mean, according to Yahoo! Finance, analysts on average are predicting 575% growth in earnings. That's 575% growth annually -- each year for the next five years!

The problem with that prediction, though, is that with no trailing profits to Renren's name, it's hard to know exactly what "earnings" the other analysts are expecting the company to grow. (Multiply a negative number by 575%, after all, and you just get a bigger negative number.) Meanwhile, true free cash flow at the company was still heading the wrong way at last report, with operating cash flows going more negative, and capital spending costs increasing. If that's not a good reason to sell a stock, I don't know what is.

Ericsson still going strong
Spinning the globe back westwards now, we turn to telecom equipment maker Ericsson, which, in contrast to Renren, analysts seem to like. This morning, the stock picked up an upgrade to buy from local analyst Swedbank -- and this one may be deserved.

While, like Renren, Ericsson is currently a company lacking trailing profits, the company is usually profitable. Analysts expect Ericsson to turn things around and earn $0.71 per share this year, and $0.88 next year -- and to keep on growing profits at an annualized rate of 22% during the next five years.

The company's already generating respectable free cash flow -- more than $2.2 billion during the past 12 months. This gives the stock a price-to-free-cash-flow ratio of 18.4, and an even cheaper enterprise value-to-free-cash-flow, once you give the company credit for its $5.3 billion in net cash. At a 22% growth rate, this would appear to make the company a pretty compelling buy -- and the stock's 3.3% dividend yield should make it even more attractive.

Long story short, I think Swedbank may be onto something here. Ericsson looks very buyable indeed.

Viva Telecom Italia!
Rounding out today's list of "unprofitable" stock recommendations, we come, at last, to Telecom Italia. During the past 12 months, TI has reported more than $6 billion in losses. It's going on its third straight money-losing year. Yet, for some strange reason, international megabanker HSBC just recommended that investors buy it. Why?

Well, the truth is that things aren't quite as bad as they look at Telecom Italia. "Unprofitable" it might be, but TI still generated cash profits of more than $3 billion over the past year. Considering the stock's $18.8 billion market cap, that makes for a P/FCF ratio of just 6.3. So why don't I like it?

One word: debt.

Unlike Renren, and unlike Ericsson, Telecom Italia is a company mired in debt. Its balance sheet is burdened with more than $49 billion in obligations, against less than $9 billion in cash. That's enough debt to more than triple the stock's P/FCF, and turn it into an enterprise value-to-free-cash-flow ratio of 19.3 -- which seems like an awful lot to pay for a company that saw its revenue shrink by nearly 9% last quarter, even as profits plunged further into the red.

With more debt than Ericsson, a smaller dividend, and less certain growth prospects (Ericsson's revenues also declined last quarter, but by less than TI's did... and Ericsson grew its earnings), I simply like Swedbank's recommendation a whole lot more than I like HSBC's. Out of the three recommendations we've gotten from Wall Street today, I like Ericsson the best.

Motley Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Facebook. The Motley Fool owns shares of Facebook.

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