Thursday'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 feature a double-upgrade for hard disk drive makers Seagate (NASDAQ: STX  ) and Western Digital (NASDAQ: WDC  ) . But the news isn't all good, so before we get to those, let's find out first why one analyst is... 

Cashing in BofI Holding
On an "up" day for the market, shareholders of Internet bank
BofI Holding (NASDAQ: BOFI  ) are watching their stock sink 2.4% (and counting). For this, you can thank the somewhat less than friendly analysts at investment bank Sandler O'Neill + Partners.

After watching their erstwhile recommendation run up nearly 150% in a year, analysts at Sandler have decided not to get greedy, and quit while they're ahead. Consequently, Sandler cut its rating on BofI from "buy" to "hold." But are they quitting too soon?

Sure, on the one hand, a 150%-ish profit is nothing to sneeze at. And yet, with a price-to-earnings ratio of only 16.6 today, it's hard to argue BofI is overpriced. Major traditional banks such as Bank of America -- slower growing than BofI -- are, after all, trading as high as 40 times earnings themselves. And as for BofI, analysts polled by S&P Capital IQ still expect to see the Internet bank grow earnings 72% over the next three years, to just over $4 a share in 2015. 

That's a compound annual earnings growth rate of nearly 20%. If BofI succeeds in hitting it three years from now, then today's 16.6 P/E ratio will look like it was a bargain.

And speaking of bargains...
Meanwhile, over at Longbow Research, the analysts think they've found a pair of stocks to recommend that are even more obvious bargains than BofI Holding.

Thursday morning, Longbow announced upgrades of both of the famous hard disk drive makers, rating both Seagate and Western Digital as buys. Let's take them one at a time and see if the recommendations check out.

Priced just under $45 a share today, Longbow thinks Seagate shares could reach $54 a year from now -- a near-21% profit for today's buyers. That's a prospect sure to attract bargain hunters, and adding to the attraction is the fact that Seagate shares sell for some very enticing multiples today. Valued on GAAP earnings, the shares cost only a 7.1 times multiple. Valued on actual free cash flow, they're even cheaper -- costing just 4.8 times the amount of cash Seagate threw off last year.

The main problem with Seagate, of course, is that the stock is currently expected to see earnings decline, not grow, over the next five years. On average, analysts are looking for a compound annual rate of earnings shrinkage of just over 4%.

That being said, between the stock's ultralow share price and its generous 3.3% dividend yield, it seems to me there's a lot of negativity priced into Seagate stock already -- and maybe even more than is justified by the projected rate of earnings decline. Personally, at prices this cheap, I think the stock's probably worth a gamble.

Western Digital
Of course, the Longbow idea I really like is Western Digital. With a P/E ratio of only 7.9, and a price-to-free cash flow ratio of just 6.2, Western Digital shares offer you the chance to own a premier name in hard disk drives, to pay multiples to earnings and free cash flow that are nearly as attractive as those found at Seagate -- and to do all this with no fear of seeing earnings decline in the years ahead. On average, analysts see Western Digital earnings stagnating, or growing only 0.1% per year over the next five years, but not declining.

To me, this makes Western Digital look like an even more attractive opportunity than Seagate. But honestly, despite the sharp rises that both stocks have recorded over the past year already, I think both remain sufficiently cheap to reward shareholders for years to come.

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Related Tickers

9/26/2016 4:00 PM
BOFI $21.74 Down -0.71 -3.16%
BofI Holding CAPS Rating: *****
STX $37.20 Up +0.74 +2.03%
Seagate Technology CAPS Rating: ****
WDC $57.01 Up +1.08 +1.93%
Western Digital CAPS Rating: ***