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, Wall Street is talking up the prospects at Kinder Morgan (NYSE: KMI  ) , but talking down Applied Materials (Nasdaq: AMAT  ) and Staples (Nasdaq: SPLS  ) . Let's find out why.

The good news first
Analysts at JPMorgan gave Kinder Morgan shareholders a reason to cheer this morning. Upgrading the gas pipeline operator to "overweight," JPMorgan assigned the stock a new price target of $39. This suggests 13% upside from today's price of $34 and change, and that's before you count the 4% dividend yield!

Whether the stock is actually worth all that money is another question entirely.

Consider: With $203 million earned over the past 12 months, Kinder Morgan currently sports a share price 143 times the amount it earns in a year. Granted, free cash flow at the company is better than the GAAP numbers would suggest -- about $769 million. Yet even so, that works out to a price-to-free cash flow ratio of 38. (And the stock's even more expensive once you factor its debt load into the equation.)

Granted, analysts are very optimistic about the company's future, and project earnings growth of 42% annualized over the next five years. Given the stock's price, though, they'd better be right about that. Anything less than perfection out of KMI, and it's going to be "look out below!"

Now for the bad news
Shifting from energy to tech, analysts responded with disdain to Applied Materials' report of lower profits and declining revenue this morning. Earnings of $0.17 per share were less than half last year's Q2 profit of $0.36, and the company even missed an estimated profit of $0.22.

Adding to Wall Street's fears, management warned that "weaker near-term demand" for its semiconductor manufacturing equipment would weigh on earnings going forward. The news prompted immediate downgrades from analysts at CLSA and Susquehanna, both of which think you should sell the stock. They may be right about that, but I'm ignoring the advice regardless.

Why? Quite simply, because when I look at Applied Materials, the shares look too cheap to resist. At today's prices, shares are going for less than 12 times earnings -- not a bad deal based on modest 8% growth expectations, and a generous 3.2% dividend yield. Plus, what analysts may be missing here is that even if earnings aren't so hot, Applied Materials is still bringing home the cash in buckets. Trailing free cash flow at the company amounts to $1.9 billion -- fully 80% better than reported GAAP earnings, and good enough to bring the stock's price-to-free cash flow ratio down into the single digits.

That's good enough for me, too, and a key reason why Applied Materials remains one of my favorite stocks -- and endorsements on Motley Fool CAPS -- in the semiconductor sector today.

Last but not least
Finally we come to Staples, subject of a "double miss" (on revenues and earnings) yesterday, and a downgrade to "sell" from Citigroup this morning.

No wonder. Staples logged a 5.5% year-over-year decline in revenues, and added injury to insult by reporting 29% lower per-share earnings to boot. But do even numbers this bad justify slapping a "sell" rating on the stock?

After all, even with the lower earnings factored in, Staples still costs only 8.6 times earnings. That's not a lot to pay for the 9%-plus growth rate Wall Street has on the stock. The more so when you factor in the stock's generous 3.3% dividend yield, and the fact that its free cash flow ($1.2 billion) significantly outruns reported GAAP earnings ($917 million).

Seems to me, Wall Street overreacted to a lackluster quarter. And with the stock now down 15% from its pre-earnings price, Staples finally looks cheap enough to buy. (But beware: Not all retailers are created equal. Learn to avoid the pitfalls in our free report on The Death of Wal-Mart: The Real Cash Kings Changing the Face of Retail. To gain instant access to this free report, simply click here.)

Whose advice should you take -- mine, or that of "professional" analysts like JPMorgan, CLSA, and Citi? 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. 273 out of more than 180,000 members. The Fool has a disclosure policy

The Motley Fool owns shares of Staples. Motley Fool newsletter services have recommended buying shares of Staples.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.


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