This Just In: Upgrades and Downgrades

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.

And speaking of the best...
What do you do when one of the biggest names in stockpicking pulls a complete 180 on one of the most popular names in retail? Personally, I listen up. And from what I hear, Citigroup had a change of heart on Target (NYSE: TGT  ) .

Predicting that "gross margin gains and productivity improvements" will lead to "positive SSS growth" in the coming year, Citi upped its price target on the stock by 39%, and swung all the way around from a "sell" rating to "buy" this morning.

From sell to buy in 60 seconds
Yet for 20 long months, Citi has been advising its clients to dump Target's stock. As of today, that counsel's cost investors more than 16 percentage points of market underperformance. Today, Citi asks that you forget what it told you back in February 2008 (sorry, Citi, CAPS never forgets) and buy Target stock. Should you listen?

Let's go to the tape
Um, no. Oh, I know Citi's record in the retail space isn't all bad:

Company

Citi Says:

CAPS says:

Citi's Picks Beating (Lagging) S&P By:

American Eagle (NYSE: AEO  )

Outperform

***

33 points (two picks)

Gap (NYSE: GPS  )

Outperform

*

28 points (two picks)

Abercrombie & Fitch (NYSE: ANF  )

Underperform

**

8 points (two picks)

Bed Bath & Beyond (Nasdaq: BBBY  )

Outperform

**

(8 points)

Home Depot (NYSE: HD  )

Outperform

**

(12 points)

In fact, the company usually gets it right when limiting its retail recommendations to the "Specialty Retail" sector, where 58% of its recommendations have beat the market over the last three years. On the other hand, Target belongs to a separate subcategory of the retail space -- Multiline department stores -- and Citi's performance in this aisle has been a bit more cluttered. On three of the four picks it's made in three years -- Macy's, Nordstrom, and Target -- Citi guessed wrong.

Zeroing in on Target
We discussed a similar upgrade of Target by Bernstein -- and a downgrade by UBS -- earlier this month. At the time, I argued that while "Target has a quality operation, decent growth prospects... [its] stock price [was] middling value at best." My opinion has not changed. To the contrary, as Target stock has risen in price, it looks only more and more overvalued.

Selling for 18 times free cash flow,  and valued at an equally moderate-seeming P/E of 18, I can certainly see why Citi is deciding to switch its stance on the retailer today. Target doesn't look all that expensive at first glance. But there are two problems with that valuation:

  • First, most analysts think Target will grow at less than 14% per year over the next five years. The resulting PEG ratio of 1.2 may not convince you to run away screaming, but it's hardly a screaming buy.
  • Second and more importantly, valuing the company based on its market cap alone ignores the warehouse worth of debt that Target carries on its balance sheet -- more than $17 billion after netting out cash, or nearly half the firm's own market cap.

Take that debt into account, and to me, the stock looks awfully overpriced.

Foolish final thought
Two weeks ago, I made the argument that while Target looked expensive, its online rival Amazon.com (Nasdaq: AMZN  ) -- debt-free, and boasting prodigious free cash flow and a rip-roaring growth rate -- was a better buy than Target. Since then, Amazon has gained 33% in value. Not to sound overconfident, but I was right about Amazon then, and I'm pretty sure I"m right about Target now. It's too expensive.

(And Amazon? You might be surprised to hear this, but yes, I think it's still fairly priced.)

Amazon.com and Bed Bath & Beyond are Motley Fool Stock Advisor recommendations. Home Depot is an Inside Value pick. The Fool owns shares of Abercrombie & Fitch.

Fool contributor Rich Smith does not own shares of, nor is he short, any company named above. You can find him on CAPS, publicly pontificating about stuff he does understand under the handle TMFDitty, where he's currently ranked No. 715 out of more than 140,000 members. The Motley Fool has a disclosure policy.


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