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.

Who's hot, who's not -- in heavy industry stocks
Wading back into the industrial sector on Thursday, Goldman Sachs -- the investment bank that everyone loves to hate -- issued a list of all the industrial stocks it loves and all the ones it hates. What follows are just a handful of the highest-profile names -- two new Goldman "sells" and two more "buys" for your portfolio. Let's see how much sense they make, beginning with...

Graco (NYSE: GGG  )
Before we start out, clear any images of baby strollers, infant car seats, and toddler high chairs out of your mind. The "Graco" that makes the baby brands is actually a subsidiary of plastic-container maker Newell Rubbermaid. The one that Goldman talked about yesterday was Graco the industrial machinery maker -- and Goldman hates it.

On its face, Graco shares look overpriced at 24 times earnings and an 8.5% projected earnings growth rate. But the truth (according to Goldman) is even worse. As related by StreetInsider.com, Goldman's note yesterday contained the ominous warning: "the market is over-estimating both the magnitude and pace with which earnings will grow."

Considering that even 8.5% growth sounds pretty anemic, and too slow to support a mid-20s P/E ratio, the possibility that Graco won't hit even this estimate should scare Graco shareholders right out of their high chairs.

Parker-Hannifin (NYSE: PH  )
The second stock getting the business end of Goldman Sachs' ugly stick yesterday was fluid power systems manufacturer Parker-Hannifin. According to the analyst, Parker's already got most of its cost-cutting measures in place, and from here earnings growth will depend heavily on sales gains. Problem is, Goldman sees little chance of an immediate recovery in sales, and so says P-H is a sell.

Sadly, Goldman's probably right about this one, too.

Sure, priced under 14 times earnings, paying a decent dividend, and boasting strong free cash flow, Parker-Hannifin isn't the most obvious candidate for shorting (hint: I don't short). But most analysts think P-H will max out at 6% annual earnings growth -- even worse than Graco. That's simply too slow to justify even P-H's modest P/E.

Honeywell (NYSE: HON  )
The news isn't all doom and gloom, though, so now let's look at a couple of stocks Goldman does believe can outperform the market. Honeywell is one. The analyst likes Honeywell's position in the booming market for commercial aerospace, as well as in oil refining and petrochemicals. It believes this company's not done expanding its profit margins yet. Assuming more revenues combine with greater profit margins on those revenues, Goldman sees no reason Honeywell shouldn't benefit from "multiple expansion," as investors decide the company's worth more than the 20 times earnings its shares currently cost.

Sadly, I have to differ with Goldman on this one. According to the analyst, market estimates of 10% long-term earnings growth at Honeywell are too conservative, and Honeywell can grow earnings at least 11% in 2013 and maybe 13% in 2014.

Problem is, neither of these numbers is big enough to justify a 20 times P/E ratio, much less the "expanded multiple" Goldman is promising. Add in the fact that Honeywell is currently a weak free cash flow generator (its $2.6 billion in trailing-12-month FCF is fully 10% below the level of reported earnings), and I see buy-rated Honeywell as just as overpriced as the two stocks Goldman is telling us to sell.

Eaton (NYSE: ETN  )
Similarly with Eaton. Don't get me wrong, Fools. I like Eaton, the company. (I have a lot of respect for Honeywell, too). But with $9.7 billion in debt on its books, and a not-cheap P/E ratio of 18, the stock's even more egregiously priced for 10% projected growth than is Honeywell.

Goldman says in its note that an inflection in the business cycle will help to drive both cash flow and earnings at Eaton for years to come. Me, I look at the gap between an 18 P/E ratio and 10% growth, and fear there's just not enough wiggle room here. Unless Goldman is right about the faster growth rate -- and everybody else is wrong by a factor of two -- this stock simply costs too much to own right now.

Foolish takeaway
Long story short, Goldman's got the right idea when it suggests shorting Graco and Parker-Hannifin. But it's dead wrong to tell you to go long Honeywell and Eaton.


 

Old industrial stock ideas like Graco and Parker-Hannifin may not play out well for investors, but did you know there's a new industrial game in town? Get ready to profit from the end of the "Made in China" era. Read all about the companies that are disrupting the whole darn industrial sector in 3 Stocks to Own for the New Industrial Revolution. Just click here to learn more.

 
 

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 01, 2013, at 5:10 PM, fabien49 wrote:

    There is a mistake in your article, the Graco company you are talking about is not the one with symbol GGG.

    There are 2 companies with the same name

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