Wednesday's Top Upgrades (and Downgrades)

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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 new sell ratings for Dell (UNKNOWN: DELL.DL  ) and J.C. Penney (NYSE: JCP  ) -- but for Foot Locker (NYSE: FL  ) , a recommendation to buy. Read on, and we'll find out why Wall Street thinks...

Foot Locker has room to run
We begin the day on a bright note, as investment banker R.W. Baird initiates coverage of Foot Locker with an outperform rating (meaning "buy"). Priced at $34 and change today, Baird believes we could see Foot Locker shares selling for as much as $45 apiece within a year -- and call me a crazy optimist, but I think Baird just might be right about that.

Why? Well consider: At $5.2 billion in market cap today, and boasting $720 million in net cash, Foot Locker shares cost only 14.2 times earnings -- or 11.8 times earnings once you net out the cash. The company pays a respectable 2.1% dividend yield, and is pegged for 12.1% long-term earnings growth by most analysts on Wall Street.

At the very worst, these numbers tell me the stock is fairly valued today, boasting a total return ratio (earnings growth plus dividend yield) precisely equal to the stock's P/E ratio. And if you credit Foot Locker for the cash in its bank account, as seems only fair, the stock is arguably undervalued -- maybe not quite as undervalued as Baird thinks it is, but 15% or so cheaper than it should be? I think so, yes.

It's time to sell Dell
Yesterday, as you've probably heard by now, Michael Dell teamed up with private equity powerhouse Silver Lake Partners to bid $13.65 cash for each outstanding share of Dell. It's not a huge premium over what the shares were fetching lately, once rumors of the buyout had begun to surface. Still, analysts appear to think it's about all you can expect to get for your Dell shares at this point.

This morning, Citigroup announced it's removing its sell rating from Dell stock, and upgrading to neutral -- but not upgrading to buy -- suggesting the banker thinks this is as good an offer as Dell gets. Analysts at Argus Research, which had previously been neutral on the stock, are even more convinced you should take the money and run, rather than hold out for a better offer. Today, Argus downgraded Dell to "sell."

That may be a bit harsh. After all, even post-offer, Dell shares still cost just barely nine times earnings, despite having a near-9% growth rate and a better-than-2% dividend yield. A counteroffer doesn't seem totally out of the question. With shares still trading $0.20 below the buyout price, it may be worth holding on to them a bit longer, just to see how this thing shakes out.

Is J.C. worth much more than a "Penney"?
Last and least, we come to department store chain J.C. Penney, which Maxim Group just initiated with another sell rating. Maxim says the stock -- currently at $19 and change -- is really only worth $10 a share.

That's a pretty contrarian call, seeing as most analysts have high hopes indeed for the retailer. On average, Street estimates for J.C. Penney are predicting 30% growth in profits, each year, for the next five years. The bigger question, though, is: Growth in what profits, exactly?

J.C. Penney is, of course, wholly unprofitable today, having reported losses in excess of a half-billion dollars over the past 12 months. So it's arguable that "growing" such negative profits might not be such a good thing. Meanwhile, the only thing we can say is surely growing at the company is its debt load. Currently, J.C. has about $2.5 billion more debt than cash on its balance sheet. And with annual free cash flow currently running at the rate of $447 million per year, that number seems only likely to get bigger.

Long story short, and analyst estimates notwithstanding, I'd still rather be short this stock than long.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. link

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Related Tickers

12/31/1969 7:00 PM
DELL.DL $0.00 Down +0.00 +0.00%
Dell CAPS Rating: *
FL $67.70 Up +0.63 +0.94%
Foot Locker CAPS Rating: ***
JCP $9.65 Down -0.13 -1.33%
J.C. Penney CAPS Rating: *