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, our headlines feature a pair of G-rated upgrades for Google and Groupon , along with a note of cautioning on one tech giant.
Caution on Cisco
The day starts on a bleak note for Cisco Systems shareholders, as same-initialed megabanker Credit Suisse cuts the stock to "underperform," and assigns a price target of $21. That new number suggests there's nearly 15% downside from today's share price -- but why?
After all, at a P/E ratio of just 13 -- or 9.6 once you subtract out the company's net cash -- Cisco hardly looks like an expensive stock. Most analysts feel confident that Cisco will grow its earnings north of 9% annually over the next five years, and the stock pays out a generous dividend yield of 2.8%. So why sell it?
StreetInsider.com, which picked up the rating this morning, explains that Credit Suisse is worried about margin pressure at Cisco, concerned that "software defined networking architectures" will eat away at Cisco's proprietary software profits, forcing gross profit margins down to 60%, and operating margins to 26% over the long term.
But here's the thing: According to S&P Capital IQ, Cisco's gross margin is already at 60.9% -- so even if Credit Suisse is right, it's only predicting a 90 basis point decline in Cisco's gross. Even if that reduction falls all the way to Cisco's bottom line, it implies only about a 5% reduction in Cisco's profitability (as the net margin falls from 20.5% to 19.6%. And Credit Suisse's other warning makes even less sense. A "decline" to "26%" operating margins? Cisco's operating margin is just 23.7% today, so a move to 26% would actually be an improvement.
Long story short, I see very little to be concerned about in Credit Suisse's report today, and certainly nothing that would necessitate a decline to $21 a share.
Buy Groupon now?
Turning now to happier news, daily deals website Groupon scored a rare upgrade this morning after analysts at Stifel Nicolaus upped their rating from "hold" to "buy." While acknowledging that Groupon shares had already rallied more than 100% before they noticed its attractiveness, Stifel argued there are still more gains in store because:
- growth is accelerating in the U.K. and holding firm elsewhere in the EU,
- a "continued shift of usage toward app-based e-commerce should work in Groupon's favor,"
- and profit margins are improving as Groupon cuts costs.
Is Stifel right?
Well, sort of. On the one hand, yes, operating profit margins do seem better at Groupon today than they've been in the past. The company's solidly in the black for operating margins today. And yet, it's also true that the company remains unprofitable from a net margin perspective, that gross profit margins at the company have fallen for three years straight, and that even operating margins -- while positive -- are down significantly from the 4.3% operating margin the company achieved last year.
Meanwhile, the strong free cash flow numbers that have argued in the stock's favor in recent years are beginning to wane. Over the past 12 months, Groupon generated cash profits of only about $75 million -- significantly better than the firm's reported $94 million GAAP loss, granted, but a lot less money than the $171 million that Groupon churned out last year.
Result: Even with a 25% projected profits growth rate, and even with Stifel's endorsement, I'm leery of investing in this stock now that its price-to-free cash flow ratio is back in the triple digits (111 times free cash flow, to be precise). My hunch: If you were fortunate enough to benefit from the doubling of Groupon's share price over the past year... now is not the time to push your luck.
Google this: What comes after "triple-digits"?
And last but not least, we come to Google. Analysts at Stamford, Conn.-based investment bank CRT Capital announced this morning that they're initiating coverage of the search giant with a buy rating, and projecting a new high for its stock price: $1,090 per share.
But honestly, this last rating seems just a weebit optimistic. Sure, Google's a great company, and a superb producer of free cash flow as well. Its $12.3 billion in trailing free cash flow exceed reported earnings by nearly 6%. But this still leaves the stock trading for 26 times earnings, and 24 times free cash flow -- that's several times the valuation of website rival Yahoo!, and more than twice the valuation of competitors Microsoft or Apple as well.
It also seems much too much to pay for a maturing giant, whose earnings analysts believe will grow at little more than 15% annually over the next five years, and whose shares pay no dividend whatsoever. Much as I like the company, I cannot endorse today's price of nearly $900 for its shares -- much less CRT's proposed quadruple-digit stock price.
Motley Fool contributor Rich Smith owns shares of Apple. The Motley Fool recommends Apple, Cisco Systems, Google, and Yahoo!. The Motley Fool owns shares of Apple, Google, and Microsoft.
The article Thursday's Top Upgrades (and Downgrades) originally appeared on Fool.com.
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