This Just In: Upgrades and Downgrades
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." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.
David versus Goliath ... times two
For two years running, the scrappy Bulldogs of Butler University (Indiana) took on the best the NCAA basketball establishment could throw at them. Granted, both times they lost the championship -- but didn't you cheer them just the same? Of course you did. Because America loves an underdog. And that's why I know you'll love this week's latest David and Goliath story: Standpoint Research's recommendation to buy Illinois Tool Works (NYS: ITW) (coincidentally, located just next door to Indiana.)
Over the past week, not one but two of the biggest names in "establishment" investment banking have come out against ITW. First Goldman Sachs told you to sell the stock on Aug. 9. Then again yesterday, Bank of America / Merrill Lynch said the same thing. Undaunted, Standpoint Research came out yesterday and told investors to buy ITW anyway -- because regardless of what the professional stock pickers are telling you -- it's a bargain.
Standpoint Research. Oh, don't tell me you've never heard of them. I've been writing about Standpoint for years, regaling you with the tale of how this "Cinderella story" of stock picking has been outperforming the big boys left and right, beating 96% of the investors we track on CAPS. At the same time as B of A and Goldman went suddenly "shy," and stopped providing their ratings to Briefing.com for public review, Standpoint is one of the stand-up analysts that's put its reputation on the line -- and its recommendations out there for everyone to see.
This week, Standpoint is taking a hard look at bargain-priced dividend stocks, made cheap by last week's sell-off. It's upgraded Chevron (NYS: CVX) and given Medtronic (NYS: MDT) a clean bill of health. And according to the analyst, ITW is another bargain: "one of the more stable and safe industrial names ... suited for those looking for a less risky cyclical name. ITW is diversified with more than 800 business units spread out across more than 50 countries around the world."
ITW is also, according to the analyst, reasonably priced: "trading at 12X trailing twelve months earnings and 10X estimates for next year." (By way of comparison, rival General Electric (NYS: GE) shares cost nearly 13 times earnings, and Manitowoc (NYS: MTW) is "priceless" -- because without profits, it has no P/E at all. Another rival, Cooper Industries (NYS: CBE) , costs a bit less than ITW, but pays an inferior dividend of just 2.3%.)
As far as ITW's prospects go, most analysts have the stock pegged for 13% annual earnings growth over the next few years. Standpoint notes that ITW has already doubled its revenue from $10 billion to $20 billion (2012 estimate) since 2003. Going forward, "ITW now sees organic growth of 6.5%-7%," but because "margins are fully expected to return to highs over the next couple of years," that should allow earnings to grow much faster than revenue. The company's also engaged in an aggressive share repurchase program, buying back 2% of its shares outstanding last quarter alone. And as you know, the fewer shares left outstanding, the fewer slices of pie ITW's total profits get sliced into.
Illinois Tool Works: Buy these numbers?
So far, so good. But now -- if you'll forgive me for the head fake -- I'm going to tell you why I think Standpoint is going to imitate the Butler Bulldogs again ... and go down to defeat on ITW.
The problem, in a nutshell, is free cash flow: ITW just isn't generating enough of it. You see, when Standpoint tells you that ITW earned enough profit over the past year to give it a P/E of 12, that's true. Problem is, actual free cash flow at the company fell quite a bit short of ITW's $1.9 billion in GAAP net income. In fact, over the past 12 months, ITW generated less than $1.1 billion worth of free cash flow. And for a company currently valued at $22.3 billion, that works out to a P/FCF ratio of 20.
Fools, I'm a fan of Standpoint. (I'm also an Indy resident, and a Bulldogs booster.) But I can't let either of these facts influence my opinion, or lead me to tell you to buy a stock that looks overpriced. At 20 times free cash flow, a 13% growth rate, and a dividend yield of 3.2%, that's just how Illinois Tool Works looks to me today: overpriced.
My advice: Much as it pains me to admit it, I think B of A and Goldman are right about Illinois Tool Works. Standpoint may be a "Bulldog" -- but ITW is just a dog.
At the time this article was published Fool contributorRich Smithdoes not own (or short) any company named above.You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 468 out of more than 180,000 members. The Motley Fool has adisclosure policy.The Motley Fool owns shares of Medtronic.Motley Fool newsletter serviceshave recommended buying shares of Chevron and Illinois Tool Works. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors.