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." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

Never mind what "Brown" can do for you ...
... because what UPS (NYSE: UPS  ) shareholders should really be thinking about this week is what an upgrade from Raymond James can do for their UPS stock. Last week, a big upgrade from RJ wasn't enough to overcome the disappointment of seeing UPS miss earnings by $0.01. (A whole penny? Horrors!) Despite growing sales 4.4% year over year, and improving its earnings at more than twice that rate, investors took one look at the words "earnings miss" and decided to sell the stock, which closed down 2.3% for the week in a generally rising market.

RJ thinks this was a mistake. That far from being a "sell," UPS is actually an even better bargain than it looked pre-earnings. So not only did the analyst up its rating on UPS to "strong buy," but it also tacked on $10 to its price target -- now $95 a share.

Now here's the real shocker: I think Raymond James is right. And all the investors who sold UPS last week? They're dead wrong.

The case for UPS
UPS may have "missed estimates" last week, but Wall Street's guessing game notwithstanding, the company actually performed pretty well. Operating margins improved by 20 basis points, helping to improve the profitability of UPS's 4.4% added revenues. Management stuck with its full-year guidance of $4.75 to $5 per share for fiscal 2012. This suggests 9% to 15% earnings growth, right in line with the 12.8% growth rate that Wall Street expects UPS to produce over the next five years.

Now, that may not sound like much for a stock that costs more than 20 times earnings today. But consider: Over the past 12 months, UPS has generated $5.9 billion in free cash flow. That's more than 50% -- or $2 billion -- better than the $3.9 billion it was allowed to claim as "net income" under GAAP. In other words, this company that so many investors are looking at as a "20 P/E stock" is actually selling for less than 13 times annual free cash flow.

When you compare this valuation to UPS's near-13% growth rate -- and factor in the 2.9% dividend yield -- UPS doesn't look expensive at all. The more so when you compare it to FedEx (NYSE: FDX  ) , which appears to cost just 14 times earnings, but which generated less than $1 billion (and less than half of its reported net income) in actual free cash flow last year.

Growth galore
And UPS could be even cheaper than that. In recent weeks, we've seen earnings reports from both eBay (Nasdaq: EBAY  ) and Amazon.com (Nasdaq: AMZN  ) confirm the strong growth in domestic parcel delivery. Last quarter, eBay reported a whopping 29% spike in quarterly sales. Amazon did even better -- 35% growth.

UPS plays a big part in this shift to online shopping. And UPS is laying the groundwork for even stronger growth abroad. Consider that while strong online sales in the U.S. contributed to 3.8% growth in average daily shipping volume for UPS in the U.S., overseas, the average volume growth of exports grew 5.4%. And while UPS doesn't break down who exactly is doing all this shipping overseas, it stands to reason that at least part of the explanation for UPS's overseas strength is its alliance with China's AliExpress, part of the Alibaba Group that Yahoo! owns a stake in.

When this alliance was first announced in 2010, I argued that it was good news for all parties involved -- all the different corporate levels of Alibaba and its owners -- but that it marked an especially "big win for UPS in its struggle with FedEx for global market share." We'll get our next update on how this rivalry is playing out when FedEx reports its own Q4 earnings in June. For now, though, I think it's enough to say that the alliance is working out nicely for UPS and supports Wall Street's generally bullish stance on the company's growth prospects.

Foolish takeaway
Thirteen times free cash flow is not a high price to pay for 13% long-term profits growth. Raymond James' upgrade shows us that Wall Street is starting to catch onto this fact. But the price is cheap enough today that you still have time to profit from the stock's run-up. Add in the fact that UPS will pay you a 2.9% dividend while you wait for the run-up to materialize, and UPS is just what Raymond James says it is: a strong buy.

In fact, I'm so certain of this that I'll stake my reputation on it. Right now, I'm heading over to Motley Fool CAPS to publicly rate UPS an "outperform."

Think I'm wrong? Follow along.

UPS isn't the only American company looking to dominate world trade. Read our new report and discover the 3 American Companies Set to Dominate the World. The report's free today, but it won't be for long -- so click quick.

Fool contributor Rich Smith owns no shares of, nor is he short, any company mentioned above. He does, however, have public recommendations available on more than 50 separate companies. Check them out on Motley Fool CAPS, where he goes by the handle TMFDitty -- and is currently ranked No. 349 out of more than 180,000 CAPS members. The Motley Fool has a disclosure policy. The Motley Fool owns shares of Yahoo! and Amazon.com. Motley Fool newsletter services have recommended buying shares of FedEx, eBay, Amazon.com, and Yahoo! and writing puts on eBay. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.


Read/Post Comments (0) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1875364, ~/Articles/ArticleHandler.aspx, 10/25/2014 12:04:48 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement