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 feature a pair of gaming upgrades for Mattel (MAT -0.66%) and GameStop (GME 1.07%). But the news isn't all good, so before we get to those, let's find out first why...
Merrill's feeling moody about DuPont
Our first ratings switcheroo of the day concerns chemicals giant DuPont (DD), downgraded this morning from "buy" to "neutral" by Merrill Lynch. This news came on the heels of a warning from DuPont that cool, wet weather this spring is likely to hurt farmers' crop yields. This poor start to the farming year could reduce their incentive to plant DuPont seeds and apply DuPont herbicides and insecticides (not wanting to throw good money after bad). If harvests turn out to be as bad as anticipated, it could also mean that farmers get less income from their crops -- and have less money to spend on DuPont products next year.
As a result, DuPont now says its earnings this year will tend toward the low end of its previous $3.85-to-$4.05-per-share guidance.
DuPont shares currently trade at $52.78 per share -- about 10.8 times trailing earnings. If the company earns only $3.85 per share this year, though, that means it could end up with a P/E ratio of closer to 13.7 in six months' time -- and so the stock could be as much as 27% more expensive than it looks. Given that it looks only fairly priced today -- based on its 7.2% projected growth rate and 3.3% dividend yield -- this suggests there's little upside visible in the stock, and it could even be a bit overpriced.
In other words, there's every reason to think that Merrill's downgrade is correct.
Game on for GameStop
Moving on now to happier news, shareholders of videogaming retailer GameStop are enjoying a nice hike in stock price (up 3.7% and counting) in response to an upgrade from Oppenheimer. Oppy nearly doubled its price target on GameStop stock, saying it now thinks the shares are worth $50, thanks largely to a belief that game consoles from Microsoft and Sony -- the Xbox One and PS4, respectively -- will drive sales upward at GameStop.
Oppy's positing $3.80 in earnings for GameStop in fiscal 2014, and says fiscal 2015 earnings could be as high as $5 a share. That latter number, in particular, looks very positive for a stock that costs less than $40 -- working out to a forward P/E ratio of less than 8.
Now, granted, GameStop isn't profitable at all today, so there's an element of "pie in the sky" to Oppenheimer's prognostication about 2015 profits. On the other hand, GameStop is generating strong free cash flow, and that's worth highlighting. Cash profits for the past 12 months exceeded $321 million (versus reported "GAAP" losses of $288 million). Is that enough?
Well, it works out to a price-to-free cash flow ratio of about 14.5 on a stock that's expected to grow profits at 10% per year over the next five years, and that pays its shareholders a 3% dividend yield. My hunch, therefore, is that the stock is actually a bit overvalued at this time, as investors rush to overpay for a piece of the expected profits from the great changeover in gaming consoles.
Long story short: Oppenheimer is coming late to this game. GameStop stock was a buy a year ago, when it cost less than half what it does today. It's no longer a bargain today.
Remember when we used to play board games?
A better bargain -- if only a slightly better one -- may be the stock of Mattel. Like GameStop, it sports strong free cash flow. In fact, its FCF number is actually a bit greater than the $807 million Mattel reported in GAAP profits for the past year.
Mattel's also GAAP-profitable, nearly net-debt-free, sports a higher growth rate than GameStop (11%), and pays a better dividend (3.3%). According to analysts at Argus Research, this is all enough to make Mattel a buy, and Argus named it so, and assigned a $51 price target, this morning.
Personally, though, while I prefer Mattel to the momentum play that is GameStop, I'd like Mattel even more if its stock price would drop a bit. For the time being, 19.5 times earnings still looks like too much to pay for a 14.3% total return ratio.
My advice would be to avoid Mattel for now, but keep this idea in your toybox. At the right price, Mattel's a quality stock, and will be worth buying.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Mattel. The Motley Fool owns shares of GameStop and Microsoft.
