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." While the pinstripe-and-wingtip crowd is entitled to its opinions, we've got some pretty sharp stock pickers down here on Main Street, too. (And we're not always impressed with how Wall Street does its job.)
Given this, 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.
Investing in an uncertain world
In world full of curveballs, there's something to be said for certainty. For this reason, investors might want to take a close look at cigarette czar Altria (NYS: MO) today. Last week, presenting at a Morgan Stanley conference in New York, the world's biggest tobacco company reaffirmed the earnings guidance it had given earlier in the year.
Presidential elections notwithstanding, Mid-East conflicts allowing, and European debt meltdown regardless, Altria announced last week that it's still on track to earn about $2.05 per share in GAAP profit this year. And while that's only about an 8% better number than Altria produced last year, when you add the company's generous 5.6% dividend yield to that growth, it's a pretty impressive total return on investment -- almost as impressive as the profit UBS thinks investors can make on the stock.
On Monday, Swiss megabanker UBS announced that it's upping its rating on Altria stock to "buy" and assigning a $36 price target to the stock. Arguing management is focused on "price realization," or maximizing returns to shareholders, UBS thinks this stock is good for about 12% profit from the stock price alone, plus another 5.6% from the divvy. The result (if it's right) should beat the S&P 500's returns quite handily at more than 17%.
But will Altria hit this target?
Let's go to the tape
At first glance, indications look good. Ranked in the top 10% of investors we track on CAPS, UBS scores a gold-filigreed 67% for accuracy on its tobacco stock picks over the past six years. To date, UBS has been right about Altria outperforming the market. Right about Phillip Morris International (NYS: PM) . Right about Lorillard (NYS: LO) and Reynolds American (NYS: RAI) , too. In fact, the only time this banker's gone on record and been wrong about a tobacco stock, is when it panned Imperial Tobacco back in 2007, and watched the stock climb regardless, much to its chagrin.
So basically, what we have here is an analyst that's proven itself at least twice as likely to be right than wrong when it endorses a tobacco stock. That's a tough record to beat, and one I'm loathe to challenge.
But challenge it I will. You see, here's the thing, Fools. Every indication tells me that only a fool would contradict a UBS recommendation on a tobacco stock. And yet, every number I see at Altria is nonetheless telling me not to buy the stock.
Consider: If Altria succeeds in earning $2.05 this year, its P/E ratio will be roughly 15.8. Even with the dividend, that seems expensive relative to long-term earnings growth estimates of 6.6% -- or even the 8% Altria assures us it's going to achieve this year.
What's more, Altria isn't even earning $2.05 a year -- not really. Fact is, according to its cash flow statement, Altria really only generates about $0.78 in real cash profits for every dollar it reports as "net income" under GAAP. So if you value the stock on its free cash flow, Altria's really trading at close to a 21 times multiple, and not the "16.8 P/E" it seems to sell for. The stock's even more expensive when you factor in debt, by the way. Altria's enterprise value-to-free cash flow ratio is a heady 24.5 -- right pricey for a 7% grower, or even an 8%-er.
Foolish final thought
So who would I buy, if I were still inclined to buy a tobacco stock, with Altria out of the running? Well, take your pick, because as it turns out, many of UBS's other tobacco recommendations appear to fit the value investor's bill.
Each of Phillip Morris International, Lorillard, and Reynolds American sport lower P/E ratios than Altria. They also pay dividend yields nearly as good. In fact, Reynolds American actually edges out Altria with a beefy 5.8% divvy. Meanwhile, Lorillard and PMI are growing faster.
Fact is, even British-American Tobacco (NYS: BTI) -- the only tobacco stock that's apparently not yet made its way onto UBS's buy list -- looks cheaper than Altria. Its 20 P/E ratio is belied by a cash flow statement showing stronger free cash flow than reported income. Its dividend yield is a respectable 2.7%. Best of all, BAT's growing faster than Altria, with most analysts predicting a 10.5% growth rate over the next five years.
While I don't necessarily think any of these stocks fit the definition of "cheap," and am not prepared to actually recommend any of them for actual purchase, they all do appear better bargains than Altria. If you're an investor for whom investing in tobacco is an option, period ... it may pay to keep your options open and think beyond the obvious pick.
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The article This Just In: Upgrades and Downgrades originally appeared on Fool.com.Fool contributor Rich Smith does not own, nor is he short, any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 273 out of more than 180,000 members. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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