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Tuesday'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, we're talking all shoes, all the time, as Wall Street visits the mall with a trio of footwear-related ratings. Deckers Outdoor (NYSE: DECK  ) and Nike (NYSE: NKE  ) score upgrades, while on the flip side, retailer Finish Line (NASDAQ: FINL  ) gets...

Tripped up by Goldman Sachs
As the market turns upward once again, Finish Line is sitting on the bench, sidelined for the moment at least by a downgrade to sell from Goldman Sachs. Why?

As relates, Goldman has been worried about the athletic footwear retailers ever since downgrading Foot Locker (NYSE: FL  ) to neutral in early August. The analyst notes the "broader U.S. athletic footwear distribution" may be robbing these retailers of sales, a hypothesis strengthened by the fact that Goldman is seeing "slower sell-through beyond a handful of marquee styles." These, say the analyst, are good reasons to be cautious about Foot Locker. "With FINL's P/E now at a 2 1/2 year high and a 24% premium to FL, we downgrade FINL shares to Sell from Neutral and see 12% downside risk to our revised $22, 12-month price target."

I have to say, that makes a lot of sense. If you're going to avoid Foot Locker at a P/E ratio of less than 13, then it's only logical that you might be leery of Finish Line, too, at nearly 19 times earnings. After all, Finish Line pays a dividend yield less than half the 2.3% divvy at Foot Locker. And if it's true that Finish Line is expected to grow its earnings a bit faster than Foot Locker, the former's projected growth rate of less than 12% still doesn't look speedy enough to justify the near-19 times P/E.

Factor in Finish Line's free cash flow tally for the past 12 months that's less than a third of its reported $66 million in net income (indicative of extremely low earnings quality), and I have to conclude: Foot Locker looks bad, but Finish Line is even worse.

Nike needs more speed
Turning now to the companies that give the shoe sellers the shoes to sell, we begin with Nike -- and an upgrade to buy from Argus Research.

Argus likes this one a lot, and thinks Nike shares, currently priced at $72 and change, could race ahead to $84 within a year -- about a 15% profit, plus a 1.1% dividend yield kicker. But if you ask me, I think that if you're wary of the valuation at Foot Locker and Finish Line, you have to positively hate the price that Nike shares are costing.

Here we've got a stock selling for 24.5 times earnings -- more than either of the sports footwear chains fetch -- yet according to most analysts, expected to grow earnings at only 11.4%, which is slower than Finish Line's projected growth rate. Not to beat a dead horse here, but if we already know one stock that looks expensive at 19 times earnings and 12% growth, then another stock that costs more, and is growing slower, must logically be even more overpriced.

Long story short, I think Argus is wrong to recommend Nike.

Better bargains outdoors?
Last but not least, we're starting to see the first signs of fall on the tree leaves, and that means it's once again time for investors to start thinking about UGG boot maker Deckers Outdoor. Unfortunately, Wall Street is thinking about this one all wrong.

Like Nike, Deckers scored an upgrade to buy this morning, this time from the analysts at Canaccord Genuity, who think the stock's going to $80. Problem is, the stock's already risen 80% over the past year, and at $67 and change costs far more than it's worth.

Deckers shares pay no dividend, and free cash flow at the company is an anemic $71.5 million, or about 63% of the number Deckers claims for its GAAP net income. The shares sell for a bit more than 21 times that net income.

Yet the company's only expected to grow its earnings at about 8% annually over the next five years, according to Yahoo! Finance figures, or 12%, according to analysts polled by S&P Capital IQ. Whichever growth estimate you choose to rely upon, the growth rate appears far too slow to support Deckers' 21 P/E ratio, much less its 33 price-to-free cash flow ratio.

In my book, the stock's overpriced, and Canaccord is wrong to recommend it.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs and Nike. The Motley Fool owns shares of Nike. 

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Rich Smith

I like things that go "boom." Sonic or otherwise, that means I tend to gravitate towards defense and aerospace stocks. But to tell the truth, over the course of a dozen years writing for The Motley Fool, I have covered -- and continue to cover -- everything from retailers to consumer goods stocks, and from tech to banks to insurers as well. Follow me on Twitter or Facebook for the most important developments in defense & aerospace news, and other great stories besides.

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Related Tickers

5/23/2016 4:01 PM
DECK $49.63 Down -0.63 -1.25%
Deckers Outdoor CAPS Rating: ****
FINL $17.14 Down -0.45 -2.56%
The Finish Line, I… CAPS Rating: ***
NKE $55.99 Down -0.49 -0.87%
Nike CAPS Rating: *****
FL $54.08 Down -0.69 -1.26%
Foot Locker, Inc CAPS Rating: ****