This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, we'll be looking at why Caterpillar (NYSE: CAT ) got its target price cut, while Angie's List's (NASDAQ: ANGI ) was upped. But first, a quick look at why...
Goldman Sachs thinks Bankrate must fall
Our marquee ratings change this morning is Bankrate (NYSE: RATE ) , operator of the website of the same name, and many home shoppers' and credit card customers' go-to site for finding up-to-date rates on financial products. Goldman Sachs downgraded the stock to "sell" this morning, and they're not shy about telling you why.
According to StreetInsider.com, Goldman says it's seeing "continued deterioration in traffic to the site, underinvestment in the business, particularly in mobile, weakness in financial services advertising, and increasing competition." So a full litany of grievances. Goldman thinks this will reduce the company's ability to earn profits going forward, and has cut its earnings estimates for the stock by 24% for this fiscal year, 27% next year, and 25% in fiscal 2015.
The analyst's new price target -- $10 --suggests a similar 25% downside risk in the stock. And yet investors are bidding Bankrate shares up this morning. Are they wrong to do so?
Sadly, I fear they are -- and here's why: Priced at 46 times earnings, Bankrate looks richly valued for the 22% long-term earnings growth it's expected to produce. The company's carrying about $110 million in debt (worsening the valuation picture). And even valued on free cash flow (the company generated nearly $64 million in cash profits last year -- more than twice reported net income), it's still selling for a 21x multiple to FCF, which is not cheap.
Long story short, if Bankrate keeps growing FCF at the rate its profits are expected to expand, there still could be a little upside left in the stock. But if Goldman's right, and if Bankrate isn't spending the kind of money it needs to keep growth going... then either the growth rate will stall, or expenses will go up as Bankrate begins spending what it needs to. Either option portends poor returns for the stock.
Next up in the bad news parade: Caterpillar. Two analysts, RBC Capital Markets and UBS, are slashing their price targets on the neutral-rated (by both) stock in the wake of an earnings report that featured missed estimates and reduced guidance. RBC now thinks Cat will be worth $92 a year from now; UBS, $85.
On the one hand, this isn't necessarily bad news -- both of the new estimates are higher than where Cat stock trades today. On the other hand, though, they may still be overoptimistic.
Caterpillar's Q1 report showed strengthening free cash flows -- about $1.2 billion for the past 12 months. Nevertheless, the company's still generating far less real cash profit than the $5 billion it reported as its "net income" for the period.
On the surface, Caterpillar stock still looks cheap, with a P/E ratio of just 10, a 14% projected long-term growth rate, and a sizable dividend yield of 2.6%. But it's what's underneath the hood that worries me. At $1.2 billion in FCF, Caterpillar sells for a hefty 46 times the amount of cash it's able to produce in a year. And if that valuation isn't quite as bad as it looked last week, well, it still isn't good.
Angie's on Wall Street's shopping list
Finally, let's end today on a "good" note, with a few words on investment banker Needham's higher price target on Angie's List.
On Tuesday, Needham upped its estimate for the value of this buy-rated stock, saying it's worth 20% more than the analyst previously thought -- $24 a share. I disagree.
Deeply unprofitable, burning cash (more than $43 million in negative free cash flow for the past year), and selling for more than 100 times the earnings it might (or might not) earn next year, Angie's List continues to look speculative to me. Although it's true analysts in general think this is a great growth story, and predict 46% annualized profits growth over the next five years, it behooves investors to ask: "Growth of what profits? How can you grow a negative number?" (And even if you can, is a bigger negative number really a good thing?)
Fact is, even if you value Angie's on one of the few numbers it's got that's actually positive -- its revenue -- the stock's carrying a 7.4 price-to-sales ratio, which is four times the average valuation in the Internet software and services industry. Long story short, placing a buy rating on Angie's looks like a speculative wager at best, and a foolhardy bet at worst.
Motley Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs.