Thursday'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, we've got two broad sectors in focus: Housing, represented by downgrades at Lennar (NYS: LEN) , Toll Bros. (NYS: TOL) , and D.R. Horton (NYS: DHI) ; and also cable, represented by renewed support for Comcast (NAS: CMCSA) and Time Warner Cable (NYS: TWC) .
Investors in America's various regional cable monopolies are cheering this morning, buoyed by upped price targets and reiterated "buy" ratings on cable providers Comcast ($42 a share) and Time Warner Cable ($114).
According to the analyst making the call (Canaccord Genuity), Comcast currently offers the "best cable fundamentals" in the industry. But more than that, by taking over NBC last year, Comcast was able to cash in on the "higher NBC ratings and sell-out rate for the Summer Olympics," which Canaccord believes boosted both revenue and cash flow at the TV unit. The analyst projects about 5% growth in operating cashflow at Comcast next year, and longer term, most analysts see the company growing its profits at about 14% a year over the next five years.
For a company that currently trades for a price-to-free cash flow ratio of less than 10, that's pretty cheap. It's significantly cheaper than Canaccord's other cable pick, Time Warner Cable, which costs about 12 times free cash flow, and carries a more leveraged balance sheet. Still, Canaccord likes TWC's "attractive balance of fundamentals and capital allocation," and calls it "an appealing PayTV vehicle for investors" and a great way to play "a turn-around in the housing market."
Turnaround is unfair play
And yes, housing does seem to be turning around. But Canaccord's bet placed on this phenomenon segues nicely into an observation from Susquehanna Research this morning: That just because the housing market is ticking up, doesn't necessarily mean investors should be buying shares of homebuilders.
Today, Susquehanna put its reputation where its mouth is, downgrading not one, not two, but three separate homebuilders on concerns that their valuations have become quite divorced from the reality of the housing market's recovery. D.R. Horton, Toll Brothers, and Lennar -- all three got downgraded to "negative" this morning -- and for good reason.
Any way you look at it, the numbers on these three stocks have gotten awfully pricey. So far this year, we've seen share prices at DR and Toll rise precisely 60%, while shares of Lennar are up an even steeper 75%. This leaves Lennar selling for a P/E ratio more than twice its projected percentage growth rate (6%) for the next five years. DR's a bit more reasonable, at a P/E of less than eight on 5% projected growth. On the other hand, Toll appears more overvalued at a 17% growth rate ... but a P/E ratio of 62!
Meanwhile, all three stocks are selling for price-to-book valuations of roughly 2.0, or about twice the level that value investors ordinarily consider a "bargain" in a homebuilder stock.
In short, the easy money in this industry has already been made. Investors looking for a second wind are probably better off taking Susquehanna's advice and looking elsewhere. So kudos to Canaccord for suggesting a couple of good ideas for them -- and special congratulations for highlighting the value play that is Comcast.
Fool contributorRich Smithholds no position in any company mentioned. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
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