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 feature upgrades for Monsanto and Select Comfort . But we'll lead off the day with a quick look at why Tiffany's recent earnings report earned it a slight hike in price target, but...

Canaccord still says "sell"
High-class jeweler Tiffany announced earnings of $0.83 per share Tuesday morning, besting analyst estimates by $0.09. Although $926 million in revenues at Tiffany fell short of the analysts' mark (they were expecting $941 million), the bumper crop of earnings, combined with 2% sales growth in the Americas and 20% growth in Asia-Pacific, were good enough to win Tiffany a reprieve of sorts from banker Canaccord Genuity.

This morning, Canaccord grudgingly lifted its price target on Tiffany shares by $3, to $57 -- but Canaccord still insists the stock is overpriced, and should be sold.

Is it? Well, let's take a quick look here. Yahoo! Finance currently lists Tiffany shares as selling for 25 times earnings, which seems a pretty penny to pay for a stock expected to grow earnings at only 12% annually over the next five years. In fact, even if Tiffany hits the high end of its now-increased guidance for this year ($3.50 to $3.60 per share), this will still leave the shares selling for more than 22 times earnings -- which is again too much to pay for a 12% grower.

Add in the important fact that Tiffany remains a company seemingly incapable of generating actual free cash flow at anywhere near the level of its reported GAAP "earnings," and I'd say that on balance, yes, Canaccord's call does appear to be the correct one. Earnings beat or no, this stock still isn't worth buying.

What's the right Sleep Number for Select Comfort?
Now let's move on to the happier news of stocks getting upgraded. Beginning with Select Comfort, we find Longbow Research upgrading the stock to "buy" and assigning a price target of $31 today. The stock's underperformed significantly over the past year, so this reprieve from Longbow is having an outsize effect on the shares this morning, with Select Comfort shooting up nearly 4% in response to the upgrade.

But is this move justified? Could Select Comfort really hit $31 within a year?

Sure, it could -- but don't bet on it. On one hand, sure, 19 times earnings may not be too great a price to pay for 15% anticipated long-term earnings growth. (I wouldn't pay that much, mind you, but some folks might be found who'd argue that a 1.3 PEG ratio isn't too much to pay.) Problem is, Select Comfort suffers from the same fatal flaw as does fellow upscale retailer Tiffany: weak free cash flow.

Free cash flow at the company amounted to barely $27 million over the past 12 reported months. That means that for every $1 in "net income" the company claims to be earning, it's actually producing less than $0.38 in real, cash profits. It means the stock -- already arguably no great bargain -- actually costs about two-and-a-half times more than it appears to cost, when you value it on free cash flow rather than on GAAP earnings.

And yes, it also means that Longbow is wrong to upgrade Select Comfort.

Can Monsanto grow you some green?
And finally, we come to Monsanto, a stock that's lagged the rest of the stock market by about 5 percentage points over the past year -- but a stock that the megabankers at UBS think is due for a turnaround, and now upgrades to "buy."

UBS bases its recommendation on its belief that Monsanto stock has suffered an "overcorrection" in response to investor fears that a bumper crop of corn this year will hurt corn prices, lead farmers to plant less next year... and thus buy less seed from Monsanto. Yet according to UBS, the company still stands to benefit from growing demand for food across the developing world. It still boasts "the highest growth opportunity in seeds and herbicides." And while, yes, this year's corn crop looks great so far, there are still "normal risks" from weather that could arise, and the possibility of a worse crop when fall planting begins in Latin America.

Be all that as it may, and whatever you think about the likelihood of a strong harvest, and the consequences that would have on corn prices and farmer incomes, there's still one very good reason to shy away from Monsanto today: the price.

Down just 10% from its recent highs of May, Monsanto stock really hasn't fallen at all far enough to justify UBS calling its decline an "overcorrection." And given that UBS is only calling for a return to $100 a share in its upgrade note, the analyst appears to be promising investors who jump into Monsanto stock today little more than a 2% gain for their trouble.

Weighed against the risk of buying a 21 P/E stock (yes, and one with weak free cash flow) with a projected growth rate of less than 14%, that really doesn't sound like an attractive prospect at all.

My hunch: UBS jumped the gun on this one. A 2% potential profit is pretty small potatoes to risk buying a stock as overvalued as this one is.

Fool contributor Rich Smith has no position in any stocks mentioned.

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

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Originally published