This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, it appears that Wall Street is focusing intently on the prospects for computer chip makers, as one analyst posits new buy ratings for Intel (NASDAQ: INTC ) and Qualcomm (NASDAQ: QCOM ) , while another trims expectations for Altera (UNKNOWN: ALTR.DL ) . Let's find out why.
Intel: the obvious choice
Our story begins with Intel, the proverbial 800-pound gorilla of the semiconductor industry, and the place where most discussions of computer chips start. One week ago today, banker MKM Partners downgraded Intel to neutral. But this morning, analysts at Mizuho Securities countered that charge with an initiation of coverage on the stock.
Rating Intel a buy, Mizuho set a $30 price target on the company, which suggests there's roughly 20% upside in the stock that currently costs less than $25. Add in a tasty 3.7% dividend yield, and gains over the course of a year could approach 25%.
But will Intel get there?
It depends. On the one hand, Intel shares cost only about 13.4 times earnings today, and even less if you back out the company's $5.5 billion in net cash. Plus, Intel could be even cheaper than it looks. Over the past 12 months, Intel generated $10.5 billion in real free cash flow from its business -- $1 billion more than its $9.5 billion in reported net income, and enough to drop its enterprise value-to-free-cash-flow ratio down to just 11.1.
On the other hand, most analysts see Intel's earnings as very near to their peak, with future earnings growth of only 5% annually expected over the next five years. If Intel can exceed that growth rate, then between the low valuation and the high dividend yield, I think the stock could reward shareholders nicely. If Intel only manages to grow at 5%, though, then MKM could have the better of this argument -- and Intel's stock could be stuck at current levels for quite some time.
Quality investors prefer Qualcomm
The picture at Qualcomm looks significantly brighter. Like Intel, Qualcomm's a huge cash generator -- $7.7 billion in free cash flow generated over the past year, versus "only" $6.85 billion in reported net income. Unlike Intel, though, analysts see huge growth potential at Qualcomm, predicting long-term earnings growth of nearly 17% per annum.
Relative to the stock's 18.4 P/E ratio, that's an attractive growth rate (once you include the 1.7% dividend yield, at least). Factor in Qualcomm's strong free cash flow, and a sizable cash hoard (even bigger than Intel's at $15 billion net of debt), and the stock's selling for an enterprise value-to-free cash flow ratio of only 14.
That could be a huge bargain on 17% growth. Mizuho says it's enough to make the stock a buy, and I agree.
Altered prospects for Altera
I'm also inclined to agree with Goldman Sachs' decision to downgrade Altera today. Warning that it sees no "clear path" for improving operating margins at Altera, and has little "visibility" into revenue growth, Goldman downgraded Altera stock from "conviction buy" to merely "buy."
But Altera may not deserve even this slightly lower rating. At a projected growth rate of 12%, the stock's prospects fall somewhere between those of Intel and those of Qualcomm. Meanwhile, Altera sports a P/E ratio of nearly 22 that's more expensive than either Intel or Qualcomm.
Granted, Altera shares many of the same advantages that favor its larger semiconducting peers. Free cash flow of $548 million is superior to reported net income. Cash reserves are flush at $2.6 billion net. Still, the EV/FCF ratio I get after crunching these numbers lands at 14.4 -- a fair price for a 12% grower with a 1.8% dividend yield, but only just fair.
Assuming the analysts are right about the relative growth rates of these three semiconductor manufacturers, Qualcomm still looks to me like the best bargain of the bunch.
Motley Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel and Qualcomm.