This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, our headlines include a downgrade for Netflix (NFLX -3.44%), but a new buy rating for Crocs (CROX -0.27%). Meanwhile, Nokia (NOK -0.81%) gets a higher price target for Christmas.
Bad news first
Might as well get this out of the way: Wall Street is greeting Netflix's blockbuster deal to distribute Disney (DIS -0.14%) films online with a chorus of catcalls. This morning, Caris downgraded the company to "below average" on worries that the deal's price tag (perhaps as high as $500 million annually) is too high. After the post-deal run-up, stock's price looks a mite steep as well.
Priced at more than 112 times earnings today (and nearly 200 times next year's projected profit), Netflix shares look awfully expensive for a company that most analysts think will grow earnings at only 21% or so over the next five years. Subtract the cash that Netflix will be paying for the Disney rights, and profits could grow even more slowly than that.
Long story short, it's rarely a great idea to pay triple digit P/Es for double-digit growth rates, and Caris would be right to downgrade Netflix for that reason alone.
Kicking Crocs up a notch
In contrast, the idea of paying a single-digit P/E for double-digit growth holds more appeal -- at least, that's the way Imperial Capital seems to see it. This morning, the analyst initiated coverage of sub-9-P/E Crocs at outperform, predicting this $13.55-per-share stock could hit $16 within a year.
If Imperial is right, that would work out to a tidy 18% gain in the stock. And Imperial Capital might be right. After all, Crocs' 10% projected earnings growth rate does look attractive relative to the stock's low valuation.
The only sticking point -- the gum underneath this buy thesis' sole, so to speak -- is free cash flow. Simply put, Crocs isn't making enough of it. Free cash for the plastic-shoe maker came to just $124 million over the past 12 months, or about 12% less than reported net income. That's enough to give the stock a price-to-FCF ratio of 10, equivalent to the growth rate, and justify a hold rating at the least.
Still, if you factor in Crocs' more than $300 million in net cash on the balance sheet, the enterprise value-to-FCF ratio on this one drops substantially. Based on that balance sheet quirk, it's possible that Crocs just might be exactly what Imperial says it is: A buy.
Nokia a go-go?
And speaking of free cash flow, we wind up today's column with Nokia, recipient of a new and improved price target from analysts at Northland Securities. Priced at about $3.70 today, Northland says Nokia is good for about a 62% profit as it rises to $6 a share over the next 12 months. Is it right?
It's hard to say. On the one hand, Nokia's numbers don't currently look all that impressive. No trailing profits. No profits expected next year, either, and cash-burn out the wazoo -- more than $965 million in negative free cash flow. On the other hand, the company's new Lumia smartphone is winning rave reviews and selling out around the globe. Headlines like these could change the cash-burn situation in a hurry, and reverse Nokia's economic fortunes in a jiff.
For the time being, $6 a share looks like a pipedream for this unprofitable stock. Then again, it was only two weeks ago that the best-case scenario for Nokia on Wall Street was $3.75 a share -- and the stock topped that number just yesterday.
Could Nokia go higher? Sure it could. But until the company starts generating numbers that we can place a solid valuation on, investors are probably better off keeping their wallets in their pockets for the time being. Fast as Nokia's rise has been, a bit of bad news could send it back down even faster.
Fool contributor Rich Smith owns shares of Nokia and Crocs. The Motley Fool owns shares of Walt Disney and Netflix. Motley Fool newsletter services recommend Walt Disney and Netflix.
