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, our headlines cover the gamut, with one analyst initiating coverage of smartphone chipmaker Qualcomm (NASDAQ: QCOM  ) at buy, while another upgrades toy maker LeapFrog (NYSE: LF  ) to similar levels. On the downside, however, a third analyst is...

Vetoing Veeco
Any "green" fanatic can tell you that LED lighting is the future. Any Cree fanatic (Lazard Capital, for example) will tell you that that LED manufacturing company is the best way to play the trend to greater use of LED for lights. It takes a brave analyst, then, to buck the trend and come out with an out-and-out sell recommendation for a major player in the LED industry -- but that's just what Canaccord Genuity just did.

This morning, Canaccord announced that it's resuming coverage of Veeco Instruments (NASDAQ: VECO  ) , a company that manufactures equipment that LED manufacturers like Cree use to, in turn, manufacture actual LED lights. Veeco, as you may recall, missed earnings rather badly last week, reporting a third-quarter loss of $0.08 per share when Wall Street had expected only a $0.03 loss.

Canaccord attributed this poor performance to "price competition" that in the analyst's opinion will prevent pricing on "MOCVD" manufacturing equipment from strengthening any time in the near future. Consequently, Canaccord is recommending that investors go ahead and just "sell" the stock now, because its weak profit margins will be a drag on performance and prevent the stock from rising in the future. I'm inclined to agree.

I don't say that lightly, though, because to be honest, there's a lot about Veeco that I still like. The company has decent free cash flow, for example -- $51 million over the past year, despite the apparent negativity of its GAAP earnings. Veeco's also got a whole lot of cash stashed up, to tide it over until the pricing environment improves. That said, at a forward P/E ratio north of 35, and with analysts projecting continued declines in GAAP profits, on the order of 14% annually for the next five years, the situation does look bleak -- and it's unlikely that investors will warm to the prospects of a business in decline, no matter how strong its balance sheet.

For the time being, Veeco looks like dead money, and Canaccord is probably right to advise selling it.

Crazy about Qualcomm
Fortunately, there are other proverbial fish in the sea -- Qualcomm, for example, which just caught an upgrade from Jefferies & Co.

According to Jefferies, Qualcomm looks attractive at today's valuation of just over 16 times earnings, and 14 times free cash flow. And I agree.

Most analysts see Qualcomm growing earnings at close to 17% annually over the next five years. Jefferies in particular sees the company's IP licensing business exceeding consensus estimates in 2014 as more carriers transition to LTE from SCDMA communication standards. Jefferies also thinks that Qualcomm is a good bet to "win the WLAN socket in the iPhone 6 or 6s," taking away this piece of component revenue from rival Broadcom. If it's right about either of these things, then this would lend support to the thesis that earnings are going to rise at Qualcomm.

On top of all this, Jefferies sees a long-term trend of investors being willing to pay expanding multiples to earnings for Qualcomm. Given that the company's P/E is already a bit below its expected growth rate -- this despite the fact that Qualcomm pays a good dividend yield of 2.1% -- I, too, think that a multiple expansion is in order.

Long story short, Qualcomm isn't just a great business. It's a great business at a very good price. Jefferies is right to endorse it.

Time to jump on LeapFrog? 
Last but not least, we turn to LeapFrog, recipient of an upgrade to "outperform" from Canada's BMO Capital -- a stock I had a few kind words for just a week ago, and a stock I'm still rather fond of today, in the run-up to Santa Season.

Priced at less than seven times earnings today, LeapFrog looks like a no-brainer. As I explained last week, though, it's not exactly that... but it is a stock you might want to think about owning. Free cash flow at the games-maker is only $38.2 million at last report. That's less than half of LeapFrog's reported $82 million in GAAP profit -- which is why the stock's not as cheap as it looks.

Still, $38.2 million is enough to give this stock a low 14.5 price-to-FCF ratio, and an even lower 11.5 ratio if you give the company credit for its cash hoard by running an enterprise value-to-free cash flow valuation. Either of these numbers, needless to say, will be a huge bargain if LeapFrog achieves the projected 17.5% compound rate of earnings growth that analysts project for it.

I think the stock's still a good bet. I think BMO is right to recommend it.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends LeapFrog Enterprises. The Motley Fool owns shares of LeapFrog Enterprises and Qualcomm.


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  • Report this Comment On November 12, 2013, at 8:49 PM, gardeningirl wrote:

    I'm new to investing but held my breath and bought 20 shares of LeapFrog, today. At under $8.00 a share, not exactly high risk, but would have kicked myself if I'd missed the boat.

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