Friday's Top Upgrades (and Downgrades)

Stocks go up, stocks go down -- and so do analysts' opinions of them. This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, we'll look at a couple of new upgrades, as All-Star stock-shop Standpoint Research takes a bullish stance on Baxter International (NYSE: BAX  ) and Foster Wheeler (Nasdaq: FWLT  ) , and then ask why interest in Exelon (NYSE: EXC  ) may be waning. Without further ado...

Welcome back, Baxter
Earlier this morning, stock researcher Standpoint announced it was upgrading shares of medical instruments supplier Baxter International to "buy," attracted by the low beta in this large-cap name, but also by the fact that so far, Baxter is a bit lower than usual. Down 13% over the past year against a mostly flat market, if Baxter returns to form, the shares should outperform.

But will they? After all, even after the stock's decline, Baxter is hardly cheap these days. Its shares sell for just under 13 times earnings, despite long-term growth estimates that don't even reach 8%. On its face, that sounds expensive -- and this is before you notice that Baxter is currently generating only about $0.83 in free cash flow for every dollar it reports in earnings.

Valued more conservatively, taking into account the firm's net debt load, and basing valuation on actual cash produced, rather than just GAAP income claimed, the stock sells for an enterprise-value-to-free-cash-flow ratio of well over 16. That's a pretty penny to pay.

Looking for a better choice in medical equipment? Try Medtronic (NYSE: MDT  ) . The company carries a similar debt load to what Baxter bears but generates more free cash flow than it reports as net income and sells for a lower P/E ratio to boot. It's not growing as fast as Baxter, granted, but in a slow-growth economy like this one, it's only a matter of degrees.

Enough about the tortoise. What about the hare?
Investors seeking a bit faster growth in their investments may be more attracted to Standpoint's other pick: engineering and construction expert Foster Wheeler. Pegged for nearly 24% annualized earnings growth over the next five years, F-W costs a very reasonable-sounding 11 times earnings. On the surface, this looks like a much better pick, but do beware...

All may not be well at Foster-Wheeler, either, at least in the short term. Historically, the company has done very well in periods of strong economic growth, often earning hundreds of millions of dollars a year, and translating the bulk of these earnings into cash. Lately, though, F-W's been finding cash hard to come by in its business, and trailing free cash flow has dwindled to a meager $25 million.

Make no mistake: Good times will come again for Foster-Wheeler, and when they do, the stock should surge. In the near term, though, make careful note of Standpoint's warning that F-W is "a high beta name." That's a sword that cuts both ways.

So is there any good news to report?
Not today, there isn't. If even the stocks getting upgrades look suspect, you have to really worry about the stocks that... aren't. Take electric utility Exelon, for instance. This morning, analysts at Wunderlich maintained the stock was a buy, but in a move that belies their confidence, quietly cut 9% off their target price, marking down Exelon to $40 a share.

Why do that to a stock that already costs a mere 12 times earnings? Perhaps because 12 times earnings is only really a bargain if those earnings are growing. In fact, however, the consensus on Wall Street is that over the next half-decade, Exelon's earnings are more likely to shrink -- on average, declining about 10% per year from last year's high-water mark through 2017.

Sure, Exelon's 4.1% dividend will help ease the sting of these declines. But when you can pay a little more and get the same, or a bigger dividend, and also get a piece of a growing earnings pie by buying shares of Dominion Resources or Duke Energy (NYSE: DUK  ) instead, what's the real investment case for owning Exelon at all?

Fool contributor Rich Smith holds no position in any company mentioned. Motley Fool newsletter services have recommended buying shares of Dominion Resources and Exelon. Motley Fool newsletter services have recommended creating a write covered straddle position in Exelon..


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  • Report this Comment On June 01, 2012, at 4:17 PM, jdmeck wrote:

    Why buy Exelon? Well if you are a long term investor you can enjoy that 4% while you wait for the price to be $45-$50. If it takes 5-10 years so what?

  • Report this Comment On June 01, 2012, at 10:56 PM, Speedster37 wrote:

    The dividend yield on EXC is 5.75 not 4.1. The confusion is the one time special dividend due to merger with Constellation. The annual dividend remains at 2.10 per share. Nuclear emits zero carbon dioxide into the atmosphere. Coal is the worst, nat gas is better but not by much. EXC is the greenest of all the electric utilities which is why I am very happy to receive their fat dividend check every quarter.

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