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." While the pinstripe-and-wingtip crowd is entitled to its opinions, we've got some pretty sharp stock pickers down here on Main Street, too. (And we're not always impressed with how Wall Street does its job.)

Given this, perhaps we shouldn't be giving virtual ink to "news" of analyst upgrades and downgrades. And we wouldn't -- if that were all we were doing. Fortunately, in "This Just In," we don't simply tell you what the analysts said. We also show you whether they know what they're talking about.

Today, we've got two new high-profile medical stock moves to examine, as both Johnson & Johnson (NYSE: JNJ  ) and Dendreon (Nasdaq: DNDN  ) snag upgrades. Then we'll switch gears and find out why one analyst thinks a McDonald's (NYSE: MCD  ) diet could be hazardous to your wealth.

A healthy regulatory environment
First up: J&J. Johnson & Johnson is the recipient of not one, but two separate analyst upgrades this morning, as first JPMorgan and then Raymond James upped the stock to "outperform." Last night, J&J confirmed that it has received approval from government regulators to proceed with its acquisition of Synthes -- a $19.7 billion transaction that's expected to close as early as tomorrow.

In other big-numbers news, J&J says its Irish subsidiary, Janssen Pharmaceuticals, will be buying back $12.9 billion worth of J&J's common stock. This accelerated buying activity is likely to lift the stock price all on its own, but as a side benefit, the reduction of shares outstanding should concentrate earnings per share among the shares remaining. Plus, J&J says investors should expect the inclusion of Synthes' profits in its results will boost adjusted earnings per share by as much as a nickel this year.

Investors are responding predictably, and positively, to the news, bidding up J&J shares by more than 1% in early trading. But me, I still have my doubts about this stock. At 3.9%, the dividend is certainly outstanding, and the P/E ratio of 17.7 doesn't look all that expensive, either. The problem here is that long-term, most analysts still see J&J growing profits at less than 6% annually over the next half-decade -- a rate that's probably too slow to support J&J's above-market P/E ratio. Presumably, acquisitions like Synthes can help boost that rate a bit... but at what cost?

Dendreon no longer doomed?
On the other hand, at least J&J has profits -- however slow they're growing. That's not true of today's other medical rec.

Valued at nearly $1 billion in market cap, Dendreon sports not a penny's worth of profit over the last 12 months. But that doesn't seem to faze analysts at Summer Street Research, who this morning looked at Dendreon's $6.50 share price and called the stock a "buy." Why? Because according to Summer Street, this stock's worth nearly three times that amount -- $18 if it's worth a dime.

Sound crazy? It may be. But consider: Dendreon has promised to earn a profit just as soon as it gets to $500 million in annual sales. It's already at $400 million, and growing fast, with sales up more than 200% last quarter. Yet at 2.3, Dendreon's price-to-sales ratio is actually lower than that of Johnson & Johnson -- a company that had zero sales growth last quarter.

Long story short, while investors might shy away from buying a business that hasn't yet proven it can earn a profit, speculators could find a lot to love in Dendreon.

Tarnished arches
And then there's today's featured downgrade, McDonald's. This morning, analysts at Goldman Sachs sacked the Golden Arches, slicing $8 off their price target (now $92) and downgrading to neutral.

And once again, the problem is growth. Goldman admits that as is, McDonald's remains best-in-class in the world of fast-food franchising. But with same-store sales growth decelerating, the analyst argues that investors ordering up profits may get faster service at Starbucks (Nasdaq: SBUX  ) , where sales grew twice as fast as at McDonald's last quarter, or Chipotle (NYSE: CMG  ) , which outgrew McDonald's by a factor of three.

Goldman's half right about this. On one hand, McDonald's 16.5 P/E ratio is too expensive for the company's growth rate to justify. On the other hand, though, I question the wisdom of buying even more expensive stocks as an alternative.

At 31 times and 55 times earnings, respectively, Starbucks and Chipotle both cost quite a lot even in light of their faster growth rates. Plus, their weak quality of earnings (free cash flow that lags reported "net income") mimics the empty caloric content of McDonald's own income statement.

Mind you, not everyone agrees with me. In fact, in the Fool's latest report, "3 American Companies Set to Dominate the World," one of these restaurant chains gets pretty high marks. As for me, though, I think investors should avoid not just McDonald's -- I'd recommend scratching all three of these stocks off your take-home menu.

Whose advice should you take -- mine, or that of "professional" analysts like JPMorgan, Summer Street, and Goldman Sachs? Check out my track record on Motley Fool CAPS, and compare it to theirs. Decide for yourself whom to believe.

Fool contributor Rich Smith does not own (or short) shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 342 out of more than 180,000 members. The Fool has a disclosure policy

The Motley Fool owns shares of Dendreon, Starbucks, Chipotle Mexican Grill, and Johnson & Johnson. Motley Fool newsletter services have recommended buying shares of Chipotle Mexican Grill, Starbucks, McDonald's, and Johnson & Johnson. Motley Fool newsletter services have recommended creating a bear put spread position in Chipotle Mexican Grill, writing covered calls on Starbucks, and creating a diagonal call position in Johnson & Johnson. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.


Read/Post Comments (1) | Recommend This Article (2)

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.

Add your comment.

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: 1911565, ~/Articles/ArticleHandler.aspx, 10/22/2014 10:34:48 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