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." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

Citi storms into the drug industry
Friday was a busy day on Wall Street, as everyone who was anyone on the Street suddenly had an opinion about drug stocks. Not all of these opinions deserved the press they got, of course. Mizuho Securities  started us off with a new rating for Questcor Pharmaceuticals (Nasdaq: QCOR  ) . The most they could say was that they were "neutral" on the stock, but even that was saying something -- judging from Questcor's 8% sell-off Friday, a lot of investors seem a whole lot less enthusiastic than that.

Teva Pharmaceutical (NYSE: TEVA  ) investors got their own dose of disappointment when an analyst at Buckingham Research cut the stock to neutral. Teva reduced guidance for full-year 2013 earnings by more than 10% on an expected 4% sales slowdown.

Meanwhile, investment banker Citigroup went utterly whole-hog on drug stocks, initiating coverage of several big names, and singling out Eli Lilly (NYSE: LLY  ) , Pfizer (NYSE: PFE  ) , and Allergan  (NYSE: AGN  ) for positive mention. Let's take a closer look at those three :

Company

P/E Ratio

Price-to-Free Cash Flow

Growth Rate

Allergan

27.1

20.8

12.7%

Pfizer

19.6

11.8

2.3%

Eli Lilly

13.3

11.2

(4%)

Allergan
You can sort of see why Citi might be inclined to like Allergan. The specialty pharma-cum-medical devices company boasts one of the higher growth rates in a patent cliff-prone industry. That said, Allergan's high price-to-earnings ratio and its nearly as-steep price-to-free cash flow ratio both mean investors are being asked to pay an awful lot to own what is -- when all's said and done -- really only a modest growth rate in this stock.

Add to this the fact that, at 0.2%, Allergan's dividend yield verges on nonexistent, and vastly lags the yields obtainable at Pfizer or Lilly, and Citi's enthusiasm for the stock is hard to explain.

Pfizer and Lilly
Citi's recommendations of Pfizer and Lilly make more sense -- but only to an extent. Both of these Big Pharma firms offer more attractive P/E ratios than Allergan, and P/FCF ratios that look downright reasonable. They also pay real, sizable dividends -- 3.5% for Pfizer, 4% at Lilly. The problem with Allergan's bigger brothers, of course, is growth.

Or rather the lack of it. Most analysts think Lilly's earnings are set to shrink over the next four years, while Pfizer, at a 2.3% projected growth rate, is hardly doing much better. In short, just because Citi sees things to like in these companies, doesn't mean you should agree.

Searching Citi's castoffs
Actually, investors may be better off investing in a company that Citi examined and then cast aside last week: Bristol-Myers Squibb (NYSE: BMY  ) .

After examining the stock, Citi found it wanting and relegated Bristol to a "neutral" rating. But if you ask me, this stock has a lot to offer to investors interested in both value and income. For value investors, Bristol's 29 P/E ratio may initially be a turnoff. Look a little closer, though, and you'll see that Bristol has been generating a whole lot more cash than its income statement lets on (and has been doing so for some years, in fact).

Over the past 12 months, free cash flow at Bristol-Myers Squibb approached $7.2 billion, giving the stock a price-to-free cash flow ratio of just 7.5. The company's growth rate is nothing to write home about -- a mere 2.6% projected over the next five years. But if you add in a 4.1% annual dividend yield, superior to that paid by any other stock named above -- the price starts to look more fair.

Foolish takeaway
Bristol-Myers Squibb still isn't quite cheap enough that I'd go out on a limb and recommend buying it just yet. But with an industry-leading dividend, modest growth expectations, and a best-in-class valuation, it's better than any of the ideas Citigroup put forward last week. It's worth keeping an eye on, with an eye to "buying on the dips."

Bristol-Myers wasn't the only drugmaker getting short shrift from Citi last week. For nearly 100 years, Merck's cutting-edge research has led to a number of medical breakthroughs. Today, however, this pharma stalwart is staring down a steep patent cliff, facing generic competition for its top-selling drug -- and getting "neutralized" by Citi. Will Merck crumble under its own weight, or will it continue to pay dividends to investors for another century? To find out if this pharma giant has the stamina to keep its Bunsen burners alight, grab your copy of our brand-new premium research report today. Our senior biotech analyst Brian Orelli, Ph.D., walks you through both the opportunities and threats facing Merck, and the report comes with a full 12 months of updates. Claim your copy now by clicking here.


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