Tuesday's Top Upgrades (and Downgrades)
Mar 12th 2013 2:08PM
Updated Mar 12th 2013 2:12PM
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 downgrade for Cisco Systems , balanced out by higher price targets at each of iRobot and Ryland Group . Let's dive right in.
First up, after watching its recommendation run up 30% from November lows, ace analyst Standpoint Research has decided to cash in its chips on Cisco Systems. Details on the downgrade are sparse, with not even StreetInsider.com knowing much more than that Standpoint has cut the stock from "buy" to "hold." But does that mean the downgrade's not justified?
Honestly... yes, I think it does. Priced at only 12.4 times earnings, and with more than a quarter of its market cap backed up by cash in the bank, Cisco hardly seems expensive today. In fact, if you backed out the company's mammoth cash hoard, Cisco trades for an enterprise value of only $85 billion. On $9.3 billion in annual profit, that works out to an EV/E ratio of just 9.1 -- hardly expensive for an 8.4% grower paying a 2.6% dividend. Plus, as you can probably guess from the size of its bank account, Cisco generates simply stupendous amounts of cash from its business -- about $1.15 for every $1 it gets to report as "net income" under GAAP.
Long story short, this stock is a whole lot cheaper than even its low 12.4 P/E ratio makes it look. Standpoint is wrong to downgrade it, and you should feel confident owning it.
iRobot a buy?
Not so with little Roomba-maker iRobot. The company just announced that it's promoted an internal hire to new CFO, upping its own projections for this year's earnings in the process. iRobot now expects to earn between $0.16 and $0.20 per share in the current quarter, a big improvement over previous estimates that said the company might only break even .
This news led Needham & Co. to up its price target on the stock to $28 this morning, on projections of stronger gross margins, and slower growth in costs. But even so, the stock looks too expensive to buy at today's prices.
iRobot shares currently cost 39 times trailing earnings, which seems quite a lot for a stock that most analysts expect to post only high-single-digit earnings growth over the next five years. Indeed, even if iRobot hits its targeted $0.80 in per-share profit this year, the stock's trading for close to a 30x multiple to earnings. Viewed under the most favorable light, the firm's strong free cash flow and sizable bank account still have iRobot trading for an enterprise value-to-free cash flow ratio of 15.8, and on 9% projected growth, that's simply too much to pay.
If it's any consolation, though... iRobot still isn't nearly as expensive as Wall Street's other dud of a price-target-hike this morning: Ryland Group. UBS raised its price target on the stock to $36 today, but still can't bring itself to recommend buying the stock. (No wonder. Ryland shares already cost $38.30, so even the higher price target fails to impress).
Priced at 45 times earnings and a staggering 3.5 times book value (and with "free" cash flow that's firmly in the negative), this stock simply has no redeeming qualities I can discern. Rather than "following the market up" with a price target hike, UBS should have just stuck to its guns -- or even downgraded Ryland Group further.
Instead, the analyst appears to have fallen into the same trap that's caught so many other investors in the "reviving home market" story. It's giving too much credit to projections of 44% profit growth, when Ryland's cash flow statement clearly shows that this growth is generating no cash whatsoever for Ryland's shareholders.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems and iRobot .
The article Tuesday's Top Upgrades (and Downgrades) originally appeared on Fool.com.
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