Wednesday's Top Upgrades (and Downgrades)

Wednesday'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 an upgrade for homebuilder DR Horton , balanced by a downgrade for its rival PulteGroup . Meanwhile, a big mortgage lender -- JPMorgan Chase -- gets a downgrade of its own.

Let's begin with that one.

Foreclosing on JPMorgan
Shares of too-big-to-fail megabanker JPMorgan are mostly stagnant today, shrugging off the effects of a downgrade to hold from ace analyst Standpoint Research. That's actually not surprising, though, considering how the analyst phrased its comments today.

Noting that JP, up 61% in value over the past year, has just hit Standpoint's price target and is trading near "an all-time high", costing 1.1 times book value and more than 9.4 times earnings, Standpoint thinks now looks like a good time to sell "into this maturing rally and lock in gains." That said, Standpoint also admits the possibility that JP shares will continue rising into "the low $60s". The analyst simply doesn't believe that this possibility justifies taking the risk that the shares will move the other way.

I suspect that's the right call: 9.4 times earnings seems to me an entirely appropriate valuation on JPMorgan Chase shares, given the stock's 2.7% dividend yield and its projected 6.5% annual profits growth rate. (Which according to Yahoo! Finance, by the way, is a full two percentage points slower than the average banking stock.) Seems to me, the stock's not overpriced by any means. But it is fairly priced, and that suggests limited upside for now. Standpoint's right to be cautious.

Building up, and building down
Similarly, I find at least some sense in the changes of a pair of homebuilder ratings that Compass Point put out this morning. In twin announcements, Compass first downgraded PulteGroup (to neutral), and replaced it with DR Horton (at buy).

Why? Actually, when you look at the numbers, the answer's pretty obvious: DR looks a heck of a lot cheaper than Pulte. It costs 7.4 times trailing earnings, to Pulte's 24.4; sells for 1.9 times book value to Pulte's 3.3; and pays a small (0.7%) dividend where Pulte pays none. In all three respects, the stock certainly appears on its face to be a better bargain than Pulte...

Except that on closer examination, maybe it isn't.

For all the factors weighing in DR's favor, and against PulteGroup, Pulte does have two advantages over its rival, from an investor's perspective: It's growing faster, and boasts higher-quality profits.

Analysts predict that Pulte will post annualized profits growth in excess of 42% per year over the next five years. That's quite an advantage over the sub-8% prediction they have on record for DR. Plus, DR Horton is burning cash at the rate of more than $1.1 billion dollars a year, Pulte is piling up cash nearly as fast as DR is burning it. Over the past 12 months, Pulte's free cash flow has amounted to a whopping $801.5 million, a number more than 250% greater than the $300 million the company reported in GAAP profits.

As a result, Pulte shares currently trade for just 9.2 times free cash flow -- and are therefore arguably both cheaper than they appear, and cheaper than shares of DR Horton as well.

These numbers are subject to change, of course, and in rather short order. Both companies are expected to report earnings, and update their numbers tomorrow. But as of today, I have to disagree with Compass Point's analysis. Seems to me, despite all surface-level indications to the contrary, PulteGroup is actually the better bargain here.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool owns shares of JPMorgan Chase & Co.

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