Tuesday's Top Upgrades (and Downgrades)

Tuesday'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. Today, our headlines include a downgrade for natural-foods producer Annie's , but upgrades for game maker Hasbro and precious-metals harvester Silver Wheaton . Let's dive right in.

Annie's gets orphaned
First up, Annie's suffered a downgrade at the hands of JPMorgan this morning, and the stock is down more than 4% in response.

No great surprise here. Priced at nearly 65 times earnings, Annie's shares were pretty obviously overvalued, even with analysts projecting growth rates north of 20% for the shares over the next five years. Free cash flow at the company remains weak -- about $0.51 per $1 of reported earnings. And to top it all off, Annie's announced last week that insider shareholders are looking to unload 2.5 million shares of the company, flooding the market with about 15% of the total share count.

That's almost guaranteed to put selling pressure on a stock too highly priced to withstand it. Accordingly, Annie's shares are likely to fall, and JP's downgrade is justified.

Hasbro hits "play"
Less obvious is the situation with Hasbro. The company reported a 16% decline in net profits yesterday and a 6% slip in revenue -- yet Hasbro shares rose 3%, and are up again on the back of an upgrade from Needham & Co. today.

Needham is keying in on unexpected strength in the company's Games and Girls segments, and modest growth in Preschool. Meanwhile, Needham predicts that the company's main area of weakness, Boys, will rebound quickly as Hasbro brings in new revenues from its Star Wars partnership with Disney.

And Needham may be right. Sure, at 19 times earnings, Hasbro doesn't look like much of a value candidate right now. But remember that the stock pays a nice, fat 3.4% dividend yield on top of its 10% projected earnings growth rate. Plus, the Force is strong with this one -- free cash flow at the company amounted to $516 million over the past 12 months, or nearly 60% more than what Hasbro reported as its net income.

I calculate about a 12 times price-to-free cash flow ratio on the stock. And between the growth rate and the dividend, I think that's plenty cheap enough to justify a buy rating. Needham is right to upgrade.

Silver lining? Must mean there's a cloud
Last but not least, we come to Silver Wheaton, which is getting a nice boost to its stock price from an upgrade to "outperform" at Macquarie. Here, though, I'm going to finally call a strike on Wall Street's judgment.

Priced at just a little over 14 times earnings, paying a 2.3% dividend, and projected to grow earnings at an even 20% annually over the next five years, all systems seem "go" for an investment in Silver Wheaton. Problem is, this company's "profits" are not what they seem. Free cash flow doesn't come close to matching reported net income of $572 million. To the contrary, over the past 12 months, this company has burned $1.8 billion in cash.

Granted, most of this cash-burn took place in a single quarter -- last quarter. But even if you throw that one out as an outlier, and evaluate Silver Wheaton on its performance over the preceding five years, the company averaged barely $116 million in positive free cash flow annually over that period, or barely 20% of what it's reporting for the past year's net income.

Long story short, given every benefit of the doubt I can scrape together for it, I see Silver Wheaton selling for about 70 times its average annual cash haul, which is too high a price to pay even if the company does succeed in generating 20% growth. On the other hand, if Silver Wheaton should burn cash as it did last quarter, the stock looks even less attractive to me. I think Macquarie's making a bad call on this one. Silver Wheaton is no "outperformer."

Indeed, the opposite seems more accurate.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Hasbro and Walt Disney.

The article Tuesday's Top Upgrades (and Downgrades) originally appeared on Fool.com.

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Originally published