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 include a pair of upgrades for Comcast and Starbucks . But the news isn't all good. So before we get to those two, let's take a quick look at why...
Ascena Retail went into the bargain bin
Does anyone still watch Jim Cramer anymore? Apparently so. Two days ago, the CNBC stock guru told viewers of his Mad Money program to sell Dress Barn operator Ascena Retail , citing a steep drop in earnings, and calling the company "too inconsistent" to own. Today, analysts at investment bank FBR Capital are taking Cramer's advice to heart, and initiating coverage of Ascena themselves -- also with a sell rating.
Are they right?
On balance, I'm more inclined to agree with Cramer, and with FBR, on this one than to disagree. But I'm not quite convinced the stock is as bad as they seem to think. On one hand, sure, 25 times earnings seems to be a lot to pay for a company that analysts expect will only grow its earnings at 15% per year over the next five years -- and that pays no dividend. On the other hand, though, Ascena boasts strong free cash flow -- $175 million produced over the past year, versus only $123 million in reported earnings.
The way I see it, the stock's better viewed as trading for "17 times free cash flow" than "25 times earnings." That's still too much to pay for 15% growth, granted, and so, no, I would not buy it. But Ascena's a whole lot closer to reasonable, fair valuation than what the analysts are leading you to believe.
Analysts tune into Comcast
Turning the channel to happier news, cable TV conglomerate Comcast announced earnings of $0.65 per share yesterday, beating analyst projections by a couple of cents, and beating on revenues as well. This performance earned the stock a price target hike to $50 from analysts at Nomura this morning, and an upgrade to "outperform" from R.W. Baird.
Nomura calls Comcast the "best-in-class" cable operation, and likes how the firm's NBCUniversal operations are shaping up. The analyst heaped praise upon Comcast for returning cash to shareholders through dividends and buybacks while simultaneously paying down debt -- and I have to admit that I am mightily impressed as well.
Paying out a 1.8% dividend, and growing earnings at north of 17% per year (per analyst estimates), Comcast shares look fairly priced at today's valuation of 19 times earnings. Free cash flow at the firm is strong, with $7.3 billion in trailing FCF exceeding the "net income" Comcast reports on its income statement by more than 7%.
The one thing that worries me about the stock is its massive debt load -- $42.5 billion net of cash. But as Nomura says, the company's working on paying that down. So long as it keeps doing that, I think Comcast shareholders will do fine.
Coffee's still on
And finally, we come to Starbucks (again). Earlier this week, I laid out the reasons that I prefer Starbucks stock over that of rival Dunkin' Brands -- but still thought the stock too richly priced to buy. This morning, analysts at William Blair seconded the emotion, but not the caution. Upgrading Starbucks shares to "outperform," Blair slapped a new price target of $85 on the shares, increasing its estimated valuation by nearly 40%.
Which seems a bit aggressive.
Free cash flow doesn't appear to be a problem at Starbucks. Although the company has yet to release its cash flow figures for the most recent quarter, as of three months ago, we know the company was still generating real cash profits at a rate almost identical to that at which it recorded GAAP net income. But this still leaves the stock trading for 34.1 times earnings today, and that's pretty rich for a stock yielding only 1.1% on its dividend, and expected to produce just-under-20% annual earnings growth.
Long story short, Starbucks is a great business, and growing just fine. The problem, as all too often happens in an overheated market such as the one we see today, is that investors have simply gotten carried away with the stock's valuation, and are paying too much for Starbucks. William Blair's endorsement today isn't going to do anything to rectify that problem.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Ascena Retail Group and Starbucks. The Motley Fool owns shares of Starbucks.
The article Thursday's Top Upgrades (and Downgrades) originally appeared on Fool.com.
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