Monday's Top Upgrades (and Downgrades)


This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. In today's headlines, we find Microsoft (NAS: MSFT) winning a buy rating, and L-3 Communications (NYS: LLL) getting a sell. Meanwhile, Foot Locker (NYS: FL) dons high-tops with a higher price target.

Well, hello, Mr. Softy!
Shares of Microsoft are following the market down this morning, but don't blame the analysts for this one. They're doing they're darnedest to keep the stock above water. This morning, analysts at Longbow Research urged investors to buy Mr. Softy, predicting a 17% profit for anyone brave enough to take their advice. But is it good advice?

At first glance, your answer is probably "no." Even at its modest 15 times earnings valuation, Microsoft shares look overpriced if all they can muster is the high-single-digit earnings growth rate Wall Street has them pegged for.

On the other hand, Microsoft is something of a cash cow, boasting a net cash balance of nearly $50 billion, and annual free cash flow of $29.3 billion (versus reported "net income" of just $17 billion). What this works out to is actually a quite reasonable 8.8 times free cash flow valuation on the stock. This looks appropriate for the growth rate and, when you factor it Microsoft's Smaug-like cash hoard, and the generous 2.8% dividend yield it finances, the stock may even be cheap.

Hey, Longbow? Nice shot!

L-3 gets an F
If only we could say the same thing about L-3 Communications. On the one hand, with a P/E ratio of less than eight, and free cash flow sufficient to drive its P/FCF ratio even lower, the stock certainly looks cheap. So why is banker BB&T downgrading L-3 to underweight (a rating that translates roughly as "sell") this morning?

Couple of reasons: First off, unlike Microsoft, L-3 suffers from an anemic growth rate that, at 2.1%, looks like it might actually underperform the inflation rate. Also unlike Mr. Softy, L-3 boasts not a net cash balance, but rather quite a lot of debt -- about $3.6 billion, net of cash on hand. So while Microsoft typifies the kind of stock that looks more expensive than it is, L-3 is a prime example of a company that costs you more than you think you're paying.

Also, its dividend yield isn't that much better than Microsoft's, and L-3's mother dresses it funny.

On your marks, get set, run?
And finally, we come to a stock that you don't often see running in the same pack as its larger peers in tech and defense: consumer sportswear retailer Foot Locker. The company just got finished reporting 59% earnings growth for Q2, in a quarter that beat analyst estimates with a stick. Analysts at Northland Securities are rewarding the news with a raised price target ($37), while Barclays is doing them one better, and saying Foot Locker is worth $38.

Granted, with the better of these two projections still only promising a 10% profit from today's prices, most investors will probably think the shares are unattractive. (After all, if 10% is all you need, you can buy an S&P 500 index fund or ETF and expect historical returns in that range... with more diversity to protect your investment).

On the other hand, with Foot Locker shares selling for less than 16 times earnings today, projected to grow 16% over the next five years, and paying a respectable 2.1% dividend, Foot Locker just might be a better -- and cheaper -- investment than your average S&P ETF.

Fool contributorRich Smithholds no position in any company mentioned. The Motley Fool owns shares of Microsoft and L-3 Communications Holdings.Motley Fool newsletter serviceshave recommended buying shares of Microsoft and L-3 Communications Holdings.Motley Fool newsletter serviceshave recommended creating a synthetic covered call position in Microsoft.

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