This Just In: More 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'll find out why Wall Street loves megacaps Corning (NYSE: GLW  ) and Merck (NYSE: MRK  ) , and why one analyst fears Nike (NYSE: NKE  ) is coming unlaced. Let's dive right in.

Beginning with Corning
With a stock priced at just eight times earnings, and a dominant share of the market for LCD television glass (plus Gorilla glass for all those iPhones and iPhone-wannabes out there), upgrading Corning looks like a no-brainer. But is JPMorgan's decision to upgrade Corning (to neutral, from underweight) really as smart as it looks?

Not necessarily. On the one hand, you can sort of see where JP is coming from. Last time JP looked at Corning, you see, the analyst pegged the stock as an underperformer, and thought the shares could fall as far as $13.50. Instead, Corning plunged as far as $11.51 before bouncing back. With its worst-case scenario now more than fulfilled, it's logical that JP would ratchet back the pessimism meter.

And yet, Corning's still a company that generates far less real free cash flow than it claims to be earning as net income under GAAP. Over the past year, GAAP earnings topped $2.5 billion, while actual free cash flow barely made it over $1 billion. At a price-to-free cash flow ratio of 19, but a growth rate that most analysts still put in the low single digits, Corning is a hard stock to recommend. So yes, I get why the analyst is upgrading it -- but I don't agree. Corning is still a "sell."

Moving on to Merck
Merck presents an opposite case. Priced at close to 18 times earnings, but pegged for low-single-digit growth, the stock doesn't look at all attractive at first glance. But with $11.1 billion in trailing free cash flow, the stock's about 60% more profitable than it looks based on GAAP accounting (which reports Merck's trailing profits at just under $7 billion).

Presumably, Merck's ability to mint cash is one of the factors that helped persuade Credit Suisse to add the stock to its "US Focus List" this morning. The fact that Merck -- alone among constituent members of the Dow Jones Industrial Average -- remained in the "green" during yesterday's sell-off probably counts as another factor in its favor. A stalwart member of Big Pharma, Merck has real staying power in a troubled market.

Yet even so, I'm just not excited about the company's valuation. Eleven times free cash flow sounds cheap, but with a growth rate of just 4%, the stock continues to look like dead money. The only caveat: Even if Merck's stock goes nowhere, at least investors can count on their 4.3% dividend checks arriving regularly. With only 71% of the company's earnings directed toward cash payouts, Merck's dividend looks to be at little risk of getting cut any time soon.

Next up, Nike
Last of all (and least of all, according to the analysts at McAdams Wright Ragen), we come to Nike. Yesterday, as you may recall, we saw Nike nemesis Under Armour (NYSE: UA  ) get sandbagged by a downgrade to neutral at UBS. According to the Swiss banker, UA was losing momentum -- and market share -- to a resurgent Nike, which was cutting prices and winning back share. Bad news for UA, of course, but good news for Nike.

So it's particularly curious to see this morning that when another analyst looks at Nike's stock, it sees something entirely opposite: a "sell."

This isn't a popular opinion. Indeed, at the same time MWR was issuing its downgrade, analysts at Janney Montgomery Scott were reiterating their buy rating on the stock, and Canaccord Genuity was issuing a note praising Nike for its "consistent innovation." But just because MWR is an outlier doesn't mean it's wrong.

Consider: At a share price more than 20 times annual earnings, Nike already looks a bit pricey for the 13% long-term growth rate that Wall Street ascribes to it. Even more worrisome is the fact that Nike's reported $2.3 billion in net income overstates actual free cash flow by about $1 billion. Valued on free cash flow, therefore, the company's trading for a really high P/FCF ratio -- about 36, or nearly three times the growth rate.

Foolish takeaway
Now mind you, no one's saying Nike is going away anytime soon. The company's a dominant brand and a great business. Indeed, here at the Fool we recently named Nike one of 3 American Companies Set to Dominate the World. (Want to know what the other two stocks are? Be our guest -- download the report for free right here.)

All MWR is saying -- and I agree -- is that 36 times free cash would be a pretty aggressive valuation for a fast-growing small cap. For a mature, grow-slow business like Nike, it's just too high a price to pay.

Whose advice should you take -- mine, or that of "professional" analysts like MWR, Janney, and Canaccord? 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. 341 out of more than 180,000 members. The Fool has a disclosure policy

The Motley Fool owns shares of Corning and Under Armour. Motley Fool newsletter services have recommended buying shares of Nike, Under Armour, and Corning. Motley Fool newsletter services have recommended creating a bear put spread position in Under Armour. Motley Fool newsletter services have recommended creating a diagonal call position in Nike.

 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 (0) | Recommend This Article (3)

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.

DocumentId: 1921787, ~/Articles/ArticleHandler.aspx, 8/2/2014 5:32:55 AM

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