At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." So you might think we'd be the last people to give virtual ink to such "news." And we would be -- if that were all we were doing.
But in "This Just In," we don't simply tell you what the analysts said. We'll also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.
Trying the clothiers on for size
When an analyst upgrades a stock, investors' instinct generally tells them to buy in response. So when two analysts rated American Eagle Outfitters (NYSE: AEO ) a buy yesterday, why did Mr. Market initially shrug, only to drop the stock through the floor today?
Perhaps it's because the analysts in question were Piper Jaffray and Caris & Company.
Citing "a more extensive margin recovery ... across our teen retail sub-group," Piper upgraded American Eagle to "buy" yesterday. According to the analyst, "merchandise margins, cost containment, and consideration surrounding M+O [company brand Martin + Osa]" will all help to grow American Eagle's profit margins -- and its profits, period -- even if the company is unable to improve comparable-store sales in the near future.
Meanwhile, Caris was busy sketching out some recommendations of its own. Initiating coverage on a raft of retail clothing stocks, Caris pegged American Eagle and Gymboree (Nasdaq: GYMB ) as out-and-out "buys," while Aeropostale (NYSE: ARO ) , Gap (NYSE: GPS ) , and Children's Place all placed in the second rung, which Caris terms "above average."
Pacific Sunwear (Nasdaq: PSUN ) and Zumiez (Nasdaq: ZUMZ ) were tagged only "average." And the lone loser among clothiers was Abercrombie & Fitch (NYSE: ANF ) , which Caris deems a "below average" stock.
And speaking of below average...
The market's response to the ratings was lackluster and mixed, at best. American Eagle in particular gained just a few pennies, despite Wall Street's two-thumbs-up endorsement. Surprising?
Not if you know the records of the analysts making the upgrades. According to CAPS, Piper Jaffray gets only about 49% of its recommendations right, while Caris fares even worse -- scoring not quite 48% for accuracy on its picks. Personally, I'm not convinced their latest recommendations will do much to turn these records around.
Buy the numbers? No. Sell 'em.
Right off the bat, American Eagle doesn't look like much of a bargain at today's price. (And remember -- today, the stock is nearly 10% cheaper than yesterday, when the analysts placed their bets.) The stock's selling for a 16 P/E, despite consensus analyst expectations that it will grow at no better than 13% per year for the next half-decade. Plus, the stock has risen more than 50% from its March lows. You're little late to the party, fellas.
Free cash flow-wise, the company generated just $37 million in the last four quarters -- just one-fifth of what it reported as "net earnings." As a result, the company looks more, not less, expensive from a free cash basis.
Worst of all, American Eagle's sales were down 2% year over year in 2008, while inventories rose 3% -- meaning things are getting worse, rather than better. Over the last year, American Eagle's operating margins have crumbled, falling to around half of their historical levels. That decline places its margins behind those of Abercrombie and Gap -- ironically, two of the companies that Caris rated lower than American Eagle. Still, over most of the past five years, American Eagle has generally had much better margins than Gap, and fared somewhat better than Abercrombie.
Foolish takeaway
Ignore the buy ratings, and instead take your cue from how the market is reacting to the analysts who made 'em, Fools. Piper and Caris are flying blind on American Eagle.
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