This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, our headlines include upgrades for both Walt Disney and Dick's Sporting Goods . But the news isn't all good, so let's start off with a few words on why...
J.C. Penney may not be worth much more than that
Just days after J.C. Penney stock surged on reports that the company had secured a $1.75 billion loan from Goldman Sachs and attracted an investment from a hedge fund run by George Soros, the stock's momentum looks likely to stall. This morning, analysts at Imperial Capital blasted Penney as "dead money," and warned investors the stock will underperform the market for at least the next two years.
It's hardly hard to guess. Unprofitable today, and expected to lose $2.40 by year-end (and a further $0.99 in fiscal 2014), J.C. Penney is a stock in dire straits. Soros may favor it for its low price-to-book ratio, and price-to-sales valuation that's just a fraction of its competitors'. But until those sales start translating into profits, Imperial just sees no reason to own it.
According to the analyst, J.C. Penney will need at least two to four years to get its profits back in the black. Other analysts are even less optimistic. On S&P Capital IQ, the tally of analyst earnings projections for Penney sees this company losing money as far out as 2018... which also happens to be as far out as analysts are willing to make projections. So quite literally, this is a stock expected to lose money "for the foreseeable future." Imperial Capital is right to warn you away from it.
House of Mouse in an upwardly mobile neighborhood?
Shifting now to the "good" news, analysts at UBS have just upgraded Walt Disney shares to "buy," and added $17 to their price target to boot.
Why? According to StreetInsider.com, UBS upped its opinion of Disney largely on the strength of the company's parks business, which it calls "underappreciated." (cf. SeaWorld IPO...) But UBS thinks strength at the firm's new LucasFilm division, and at the new(ish) Marvel, will also help to create an "EPS revision cycle" to the upside as other analysts get more bullish on the stock.
Put it all together, and UBS sees Disney earning $3.50 a share this year, then growing that by strong double-digit percentages over the next couple of years. In both cases, this is a more bullish prognosis than other analysts are making. Consensus earnings estimates for Disney are closer to $3.45 for this year, with roughly 12% growth thereafter.
But here's the thing: Even if UBS is right, $3.50 per share in earnings would still leave Disney shares selling for 18 times earnings today. Free cash flow right now lags reported net income pretty significantly -- $3.7 billion FCF versus $5.6 billion net income. So arguably, the stock's selling for an even higher multiple based on its real, cash profits. In either case, UBS' projection of 18% or lower annual growth seems only fast enough to make the stock worth holding (if even that), and not buying.
Long story short, much as I like the company, Disney stock seems too richly priced to buy.
Dick's scores an upgrade
Similarly, I'm just not enthused about Dick's Sporting Goods, despite the fact that this one, too, has won an upgrade today (from Barclays). While Dick's is growing a bit faster than Disney, the stock also costs quite a bit more at 21 times earnings. Its dividend yield (1.1%) is almost identical to Disney's (1.2%).
And unfortunately, its relationship of free cash flow to reported income is as well. Dick's generated all of $219 million in free cash flow last year. That works out to about $0.75 in real cash profit for every $1 it claimed to have "earned" under GAAP accounting standards. So once again, we have here a stock that looks overpriced valued on simple GAAP P/E ratios and forward growth rates... and looks even more overpriced when valued on its free cash flow.
I guess when you get right down to it, weak free cash flow and anemic dividend yields are good enough to merit buy ratings from Wall Street -- but they're not good enough for me. I honestly can't endorse any of the buy ratings we're seeing on the Street today.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs and Walt Disney. The Motley Fool owns shares of Walt Disney.
The article Monday's Top Upgrades (and Downgrades) originally appeared on Fool.com.
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