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." The pinstripe-and-wingtip crowd is entitled to its opinions, but we have some pretty sharp stock pickers down here on Main Street, too. And we're not always impressed with how Wall Street does its job.
So 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, one analyst in particular was talking up shares of Activision Blizzard (Nasdaq: ATVI ) and priceline.com (Nasdaq: PCLN ) , and searching for bargains at AOL (NYSE: AOL ) and Google (Nasdaq: GOOG ) -- but not Yahoo! (Nasdaq: YHOO ) . Let's find out why.
Game on ... and game over
Beginning the day on an up note, Jefferies initiated coverage of electronic-gaming giant Activision Blizzard with a "buy" rating this morning. Arguing that the company's existing Call of Duty and World of Warcraft franchises both look "solid," with new revenue streams coming on line from new franchises such as Skylanders, Jefferies makes the case for "persistent margin expansion" at Activision and thinks "direct-to-consumer digital downloads" will help to make Activision more profitable than ever in the coming years.
As a result, Jefferies sees Activision shares rising 36% in value to hit $16 a share within the next 12 months. Let's hope the analyst is right about that, because so far this year, Activision shares have pretty much sat out the stock market rally entirely, actually losing a few fractions of a percent as the rest of the S&P 500 raced 17 percentage points higher.
Why is the stock still stuck? Consensus analyst projections of 10% profits growth probably don't help -- not with the stock selling for nearly 17 times earnings already. On the other hand, simple P/E ratios don't wholly reflect the value in these shares. Consider: With $3.2 billion in cash, and annual free cash flow in excess of $1 billion, the business that is Activision currently sells for just 9.3 times the amount of cash it churns out in a year.
Viewed from this perspective, 10% growth (plus a 1.5% dividend) is more than enough to justify the stock's price. In short, Jefferies may be too optimistic in predicting $16 a share, though there's every reason to believe that Activision can tack on a couple of bucks by year-end.
The "Price" is not right
Similar story with priceline.com. Bears look at this one and worry that Priceline's 25 P/E ratio is a bit pricey in light of 22% long-term growth expectations. Jefferies, however, looks at the same stock everyone else sees, but says it's worth $740 a share -- more than 23% higher than today's price.
Where's the disconnect? Once again, it's a question of what kind of "earnings" you focus on, and whether or not you notice the bulging bank account at Priceline. With $2.5 billion in net cash on its balance sheet, Priceline sports an enterprise value about 8% cheaper than its $30 billion "market cap." Meanwhile, the $1.4 billion in positive free cash flow it generated over the past 12 months is nearly 14% more than the $1.2 billion it reported as GAAP earnings.
Result: The P/E on this one may be "25," but Priceline's enterprise value-to-free cash flow ratio is a much more reasonable 19.6. If the company succeeds in growing its profits at the pace analysts predict, then chances are Jefferies is right about this stock as well: Priceline.com is a "buy."
Take two, and call your broker in the morning
And finally, we come to Jefferies' review of the Internet search sector, the two stocks it likes (Google and AOL), and the one it does not (Yahoo!). Most investors still think of Google as a desktop search engine. But according to Jefferies, Google today is more of a play on the growth of "emerging mobile, display, and online video businesses." (And this is a good thing, because these are all "big and growing fast enough to move the needle.") The analyst also likes AOL, which it praises as "laser-focused" on transforming itself into "a premium online advertising business."
Yahoo!, on the other hand ... well, according to Jefferies, Yahoo!'s primary focus lately has been on "giving up market share ... to other players." The analyst does like Yahoo!'s progress toward monetizing Alibaba but warns that "execution risk" on the deal is still high and "the time horizon is long." Given Yahoo!'s track record, Jefferies can't bring itself to give Yahoo! more than a "hold" rating.
Given that Yahoo! shares still cost nearly 17 times earnings, versus 12% earnings growth, that rating's probably prudent. But Jefferies might also want to rethink its optimism about Google and AOL.
Google costs more than 20 times earnings, and even with strong cash generation, it's no bargain on a price-to-free cash flow basis. AOL, meanwhile, is still too much of a wild card to stick a value on. Sure, its $1 billion patent sale earlier this year has AOL trading in the single digits for trailing P/E. But unless you think AOL has more billion-dollar patents lying around and can repeat this feat in future years, chances are the stock's still overpriced.
Whose advice should you take -- Rich's, or that of "professional" analysts such as Jefferies? Check out Rich's track record on Motley Fool CAPS, and compare it with theirs. Decide for yourself whom to believe.