Monday's Top Upgrades (and Downgrades)

Monday'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, Wall Street turns pessimistic and downgrades two popular stocks -- Warren Buffett's favorite refiner, Phillips 66 , and also the company that used to be Coinstar, now called Outerwall . On a brighter note, though, one analyst just upped its price target on a third stock that recently came onto my own investing radar. Its name:

Arctic Cat
Starting the day off on a bright note, this morning analysts at Feltl & Co. have initiated coverage of snowmobile-and-ATVs-maker Arctic Cat, reiterating their buy rating, and upping their price target on the stock to $61 per share. And I have to say -- Feltl is right. Arctic Cat does look attractive.

Priced just over 17 times earnings today, and expected by most analysts to grow its earnings at 20% annually over the next five years, Arctic Cat appears on-its-face "cheap." Adding to the attraction, the stock boasts a clean balance sheet with nearly $50 million cash in the bank, and no debt. It pays a modest dividend -- 0.7%. And its free cash flow, while not stellar, looks entirely respectable at about $40.7 million, versus $43.2 million in reported GAAP earnings.

Granted, much of the stock's attractiveness hinges upon its achieving a pretty aggressive growth target. But if Arctic Cat really can grow at 20%, I think Feltl is 100% right to recommend it.

Time to deep-six Phillips 66?
Turning now to the day's less happy news, we find Argus Research removing its buy rating from Phillips, a stock that's handily outperformed the S&P 500 over the past year.

Will it continue to do so? Argus votes no, and so now rates Phillips 66 a "hold." And yet, when you look at Phillips stock, the valuation really doesn't look all that bad. Depending on whose estimates you believe, Phillips is likely to grow its earnings at either less than 2% annually over the next five years (Yahoo! Finance) or more than 5% (S&P Capital IQ). Either way, the growth rate certainly isn't lightning-fast -- but it may be fast enough for the price.

Phillips shares cost less than eight times trailing earnings. Free cash flow lags reported earnings by about 6%, but that's still enough cash profit coming in the door to price the stock at just eight times FCF, as well. If we take Capital IQ's projected growth rate of 5% as given, therefore, and add Phillips' promised 2.2% dividend yield to projected returns, Phillips shares actually look pretty fairly priced today -- maybe a wee bit expensive, which could explain Argus' caution about the stock. But generally speaking, the shares still look pretty good to me.

What are the outer limits for Outerwall stock?
Finally, we come to Outerwall -- the company originally known for its Coinstar coin-counting kiosks, and now perhaps best-known for its Redbox DVD vendors. (Outerwall also has a new business now, recycling used mobile phones, tablet computers, and mp3 players.)

Pacific Crest isn't particularly impressed by any of these ventures, however, and on Monday downgraded the stock to "underperform." The analyst is particularly unenthused about the DVD rental business, which it sees falling victim to online streaming of videos, and for which Pacific Crest is forecasting "double digit" revenues declines for the foreseeable future.

They may be right about that. DVDs do appear to be going the way of the dodo. And yet, most analysts still think that Outerwall will beat the odds, and keep its business growing at about a 20%-per-year clip. If they're right, and Pacific Crest is wrong, then this could be a particularly dangerous stock to short.

Outerwall only costs 13.5 times earnings, after all, which seems a very modest price to pay for 20% growth. Its trailing free cash flow number is $140 million -- 8.5% ahead of reported GAAP earnings, which makes the stock look even cheaper on the one hand, and isn't the kind of number you'd expect to see at a business in decline on the other.

Long story short, while I'm not fully convinced of the stock's long-term viability myself, I'm pretty sure Outerwall's share price today builds in a big enough margin of safety that there's no reason to rush right out and sell (or short) it. Investors who are selling the stock in reaction to Pacific Crest's downgrade today are, in my opinion, overreacting.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool owns shares of Arctic Cat.

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