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 upgrades for each of consumer brands Men's Wearhouse (NYSE: MW ) and Stanley Black & Decker (NYSE: SWK ) . But the news isn't all good, so before we get to those two, let's take a look at why expectations for Skyworks Solutions (NASDAQ: SWKS ) are...
Falling back to Earth
Perhaps shaken by Cypress Semiconductor's (NASDAQ: CY ) comments about "a customer push out of certain new handset programs to Q1, as well as order reductions at various end customers in China to balance inventory levels" yesterday -- and the resulting 15% collapse in Cypress' share price -- analysts at B. Riley are taking the opportunity today to pull back on their enthusiasm about fellow mobile chipmaker Skyworks Solutions.
Riley cut its rating on Skyworks to "neutral" this morning, although it left its price target for the stock unchanged at $28 a share. Investors, meanwhile, are accenting the negative. Although they gave Skyworks a pass on Cypress' bad news yesterday, today, they're shaving 3% off the company's market cap -- and if you ask me, this appears to offer new buyers an opportunity to get into Skyworks on the cheap.
Granted, at 19 times earnings, Skyworks still looks expensive for a stock expected to grow earnings at "only" 16.5% annually over the next five years. But looks can be deceiving. Skyworks boasts $400 million in cash in the bank, without a drop of debt. That alone is enough to make its ex-cash P/E more palatable at 17.2. Plus, in contrast to rival TriQuint Semi, Skyworks is now generating free cash flow in excess of reported net income -- meaning it's even cheaper than it looks.
I calculate about a 16 times enterprise value-to-free cash flow ratio on the stock, which should be cheap enough to justify buying Skyworks if growth meets expectations. Still, just in case it doesn't -- just in case Cypress' warning really is indicative of something going awry in the broader smartphone market -- it might be worth waiting to see if Skyworks drops a bit more before buying, to account for a possible slower-than-expected growth rate.
A bigger margin of safety is never a bad thing.
The trouble with tickers
At the risk of confusing matters a bit, I've chosen Stanley Black & Decker -- a stock with a ticker symbol almost identical to Skyworks' -- as our next rating to review. There is one big difference between Stanley and Skyworks, though: Wall Street loves Stanley.
On Tuesday, analysts at Gabelli announced they were initiating coverage of Stanley Black & Decker with a buy rating and a $105 price target. According to StreetInsider.com, which picked up the rating this morning, Gabelli likes Stanley's "exposure to improving U.S. residential and non-residential trends, along with double-digit emerging market growth." Combined, the analyst thinks Stanley can achieve "mid-single-digit organic growth" -- and then enhance that with acquisitions.
Indeed, this seems a popular assumption, with most analysts already counting on Stanley to produce earnings growth of nearly 14% annually over the next five years -- significantly higher than "mid-single digit." On one hand, all of this appears to make Stanley shares look attractively priced: 16.6 times earnings (the current valuation) looks very close to where you'd expect a stock to trade when its dividend yield is 2.2%, and its growth rate 14% or thereabouts. However, there is one wrinkle in Gabelli's analysis.
According to the analyst, one of the things it likes best about Stanley is the company's "industry-leading free cash flow yields." And yet, the truth of the matter is that Stanley's free cash flow over the past year has amounted to only $353 million -- which is less than half of its reported $875 million in GAAP "profits."
To my eye, that's not an attractive relationship at all. I want to own companies whose real cash profits exceed what they are allowed to claim on their GAAP financial statements -- not lag them. And that's just not the case with Stanley. Modest P/E aside, with a price-to-free cash flow ratio of more than 40, Stanley stock does not look cheap enough to buy.
Men's Wearhouse: Do you like the way they look?
And finally, we come to Men's Wearhouse, our third ratings mover of the day, and the one just endorsed by Goldman Sachs. Could our third stock be the charm?
Goldman certainly thinks so. Initiating coverage with a buy rating and a $45 price target, Goldman praises the "annuity-like features" of Men's Wearhouse's tuxedo rental business, and argues that the stock's 18% sell-off post-second-quarter earnings "creates an attractive entry point." Says the analyst: "The stage is set for a dynamic next 12 months for MW as management reviews strategic alternatives for non-core asset K&G, including a potential sale, returns excess capital to shareholders, and focuses on organically growing its highest return Men's Wearhouse (U.S.) and Moores (Canada) banners."
Personally, though, I think Goldman is getting a little ahead of itself. Most analysts, after all, predict only 8% long-term earnings growth at Men's Wearhouse, and that does not appear to justify either the stock's price or Goldman's optimism.
Right now, Men's Wearhouse shares cost more than 12 times earnings based on GAAP profits, cost more than 14 times free cash flow, and have an enterprise value (market cap plus debt) of nearly 17 times free cash flow. This has me thinking the shares are somewhere between 50% and 100% overvalued on an 8% growth rate. It certainly does not leave me with the impression that Men's Wearhouse is going to miraculously shoot up 34% to $45 a share.
Long story short, for Men's Wearhouse to deserve Goldman's "buy" endorsement, it will have to grow much faster than the 8% it's projected to. Growing by even the 12% growth rate projected for the retail industry as a whole might suffice. But if it can't do even that, it doesn't deserve your investing dollars.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Cypress Semiconductor.