Wednesday'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 downgrades for Compuware (no surprise there) and H&R Block . But on the bright side, Dunkin' Brands perks up on news of a new buy rating.

Good news first
Let's start the day off on that bright note. This morning, analysts at Miller Tabak upgraded shares of Dunkin' to "buy," and raised their price target for the stock to $38.

Now at first glance, this might seem a foolish move. On second glance as well. Here's why: Dunkin' shares currently cost a good 74 times earnings, while they're expected to grow these earnings at only 17% per year over the next five years. Even with a tidy 1.8% dividend to boost its value, this seems like a high price to pay.


And it is... even if it's not quite as high a price as it looks. With $130 million in trailing free cash flow to its credit, Dunkin' shares actually sell for "only" 27 times annual cash profits. That's a bit more reasonable considering the stock's high growth rate. Personally, though, I still don't think it makes the stock cheap enough to buy, especially once you factor debt into the picture. (Net of cash on hand, Dunkin' is carrying about a $1.7 billion debt load.)

Long story short: I expect Miller to get scalded on this call.

Block gets chipped
But what about the day's downgrades? We'll take H&R Block first. Here, it's Compass Point making the call, and that call is "down." The analyst cut Block to neutral from buy this morning. Curiously, however, at the same time as it was cutting its rating, Compass Point raised its price target on the stock to $19.50 a share. Why?

According to StreetInsider.com, which reported the downgrade, Compass Point thinks H&R Block's business has stabilized and will see earnings rise "over the next several years." Be that as it may, the analyst thinks "risk/reward" is balanced at today's share price of nearly 15 times earnings.

I agree.

Fifteen times earnings might look cheap for a projected 12% grower like Block, especially with the firm's beefy 4.2% dividend yield. Problem is, Block isn't quite as profitable as it looks. Real free cash flow for the past 12 months has been only $275 million, meaning that the company is only really generating about $0.74 in support of every $1 it claims for its "net income." That works out to a price-to-free-cash-flow ratio of 19 on the stock, which even with the dividend factored in, looks a bit expensive to me based on 12% growth estimates. Fact is, while investors may be disappointed at Compass Point's call, they should probably be counting their blessings. This is a stock the analyst could as easily have downgraded to sell as to neutral.

Compuware counts on a buyout
Last but not least, we come to Compuware, a company that recently made headlines with its plan to IPO its Covisint subsidiary, and even more recently got even more attention when major shareholder Elliott Management offered to buy the company out for a combined $2.3 billion purchase price.

Northland Securities downgraded Compuware today in response to Elliott's offer, and well it might. After the news broke that Elliott was offering $11 apiece for Compuware shares, the stock quickly soared to within a few cents of that offer. It sits at $10.80 a share today, suggesting there's limited upside left in the absence of a competing offer.

Not meaning to be mean, but with Compuware currently costing nearly 34 times earnings, growing at less than 11% a year, and paying no dividend whatsoever... it's hard to see why anyone -- and certainly anyone other than Elliott -- would want to buy this stock. My advice: Take advantage of Elliott's offer, and the surge in stock price it's sparked. Take the money and run.

Motley Fool contributor Rich Smith has no positions in the stocks mentioned above. 

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

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