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 upgrades, from separate analysts, for Chinese Internet stocks Sohu.com (NASDAQ: SOHU ) and SINA (NASDAQ: SINA ) . But the news isn't all good.
Accenture-ating the negative
Multinational IT consulting firm Accenture (NYSE: ACN ) put up some impressive numbers in yesterday's fiscal Q3 earnings announcement. Despite "missing estimates" on revenue, Accenture delivered stronger gross margins for the quarter (33.9%), helping to offset rising operating costs. As a result, operating margins widened and the company ended up reporting $1.14 per share on the bottom line. Meanwhile, the company signed up more new business (bookings) than it billed as revenues in the quarter -- a book-to-bill ratio of about 1.15.
Nonetheless, Wall Street is reacting negatively to the news, focusing on the quarter's revenue weakness, and on Accenture's new target of $6.7 billion to $7 billion in revenue for Q4 -- short of analysts' hoped-for $7.4 billion. Both UBS and Raymond James are accordingly removing their buy ratings, and downgrading the stock to various flavors of "hold." UBS in particular worries that we're seeing the same weakness in corporate IT spending at Accenture, as afflicted both Oracle and IBM earlier in the quarter. The analyst has thus cut its price target from $85 a share, to just $77.
Is that the right call?
Actually, yes. I think it is -- and here's why: Priced north of 16 times earnings today, Accenture looks more than fairly priced for its sub-12% profits growth estimates, even accounting for the stock's decent 2% dividend yield. Free cash flow at the company is good, not great, running about 5% ahead of reported earnings. That's enough to make the stock a bit cheaper than it appears, but not enough to make it look "cheap," period. As such, while I see no compelling need to sell it, neither do I see much reason to rush right out and buy Accenture.
Now for the good news
On the "plus" side, Friday brought reports of reprieve for two Chinese Internet stocks. Let's take them one at a time, beginning with SINA. Analysts at Maxim Group removed their "sell" rating from SINA stock today, upgrading the shares to "hold." That may not sound like a huge vote of support -- and indeed, investors aren't really giving it any weight today. Personally, I think the investors have the better of this argument.
Here's why: SINA shares are up a modest 9% over the past year, half the gains of the rest of the stock market. Even so, they currently cost well over 100 times earnings. That's quite a large multiple to be paying for a stock that pays no dividend, and burned more than $20 million in cash last year. Regardless, SINA bulls are probably putting their faith in analyst estimates that the company will (according to Yahoo! Finance) deliver 207% annual earnings growth over the next five years.
You read that right. Somewhere out there, someone is apparently telling investors -- with a straight face, no less -- to expect SINA to triple its earnings this year, do it again next year, then keep on doing it for three more years. Tripled earnings, year in and year out. It sounds like pie in the sky to me, and pricey pie at that. And it's pie I'd personally more inclined to sell than to buy.
I'm a bit more sanguine on Sohu.com's chances, however. Here, the estimates of 16.6% annualized earnings growth seem more grounded in reality. And while the stock costs a hefty 29 times earnings today, the stock's strong free cash flow -- $271 million generated over the past year, versus reported GAAP earnings that only claim the company earned $88.5 million -- tell me this stock is quite a bit cheaper than it looks on the surface.
Taking a close look at the stock today, HSBC Securities announced it was pulling its "underweight" rating and upgrading Sohu to "neutral." I think the stock looks even better than that. At a price-to-free-cash-flow ratio of less than 9, and strong mid-teens growth prospects, I think Sohu's cheap enough to buy.
Motley Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Accenture, SINA, and Sohu.com. The Motley Fool owns shares of International Business Machines and Oracle.