Wednesday's Top Upgrades (and Downgrades)

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 cuts to price targets at Qualcomm (NASDAQ: QCOM  ) and Apple (NASDAQ: AAPL  ) . But the news isn't all bad, so before we address those two, let's start on a positive note.

Cliffs could climb
That has got to hurt. No sooner did Cliffs Natural Resources (NYSE: CLF  ) CEO announce he's planning to retire yesterday, than out came an analyst and recommended buying the stock.

Musing that Joseph Carrabba's exit from the company opens up new directions in which the company could go (spinoffs, going private), one thing BB&T thinks will not happen is a dilutive stock offering -- and just removing that risk from the table may allay some investor concerns. Additionally, BB&T notes that iron ore prices appear to be ready to improve in 2014 -- which clearly would be a good thing for a company like Cliffs, which sells the stuff.

None of which makes for a good reason to buy Cliffs Natural Resources, however.

Unprofitable today, and priced at close to 10 times the profits that it might earn next year (and might not), Cliffs shares look dangerously overpriced to me. Yes, even though they've fallen 64% over the past year, I think there's still room to the downside. Free cash flow at the company is nonexistent. To the contrary, Cliffs burned through nearly half a billion dollars over the past 12 months, adding to the burden on a balance sheet that's already $3.4 billion in hock (net of cash).

Long story short, Cliffs' hole remains deep. It's going to take more than a departing CEO to piggyback a "buy" thesis on this one.

Now for the actual good news
In contrast, I'm quite a bit more optimistic about a pair of companies that just got their price targets cut at Canaccord Genuity. This morning, Canaccord announced it was reducing price targets on both Qualcomm and Apple -- to $84 and $530, respectively. And yet, considering how low both stocks have sunk already, what this really works out to is the potential for Apple to gain 25%, and Qualcomm... 40%!

Needless to say, at the same time as it is ratcheting back its price expectations slightly, Canaccord still recommends "buying" both stocks. Let's take them one at a time, and see what that's still really good advice.

Qualcomm
Priced under 17 times earnings, expected to grow these earnings at 18% per year over the next five years, and paying a 2.3% dividend yield, Qualcomm looks like a great buy at first glance. A second glance suggests it's not quite as good a deal as it seems initially. But it's still plenty cheap.

Over the past 12 months, Qualcomm generated $5.4 billion in positive free cash flow. That's about 14% less than it reported for net income. However, Qualcomm's balance sheet shows that it's sitting on about $13.5 billion in cash -- so if the company's earnings aren't quite as robust as they seem, neither is its market cap.

These two factors basically cancel each other out, such that Qualcomm emerges in the end with an enterprise value-to-free cash flow ratio of 17, or basically identical to its P/E. Valuation-wise, I think this is a fine price to pay for 18% growth. And Qualcomm's 2.3% dividend yield? That's just icing on the proverbial cake.

Apple
What's better than cake with icing? (Apple) pie a la mode. At Apple we're looking at an even more enticing valuation proposition, where the stock's P/E of 10 is much cheaper than Qualcomm's, its dividend (2.9%), greater, and its projected growth rate (21%), faster.

Meanwhile, like Qualcomm, Apple sits atop a mountain of cash more than $39 billion tall. And to top it all off, the company's generating more free cash flow than it reports as net income ($45.4 billion FCF versus $39.7 billion in income), rather than less FCF, as is the case at Qualcomm.

Result: If I like Qualcomm stock a lot (and I do), then I have to like Apple even more. (And I do.)

Motley Fool contributor Rich Smith owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and Qualcomm.


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