Monday'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 ratings news covers the gamut, from heavy industry to asset-lite 3-D printing, to... cheese.

Let's start with the cheese.

Analysts spell Kraft "K-R-F-T"
The trading week dawned bright for shareholders of Kraft Foods (NASDAQ: KRFT  ) ,as analysts at Morgan Stanley awarded the stock an upgrade to overweight on the theory that the stock has superior earnings visibility, is restructuring to reduce costs... and that its looks like a bargain relative to its peers. And to an extent, Morgan is right.

Run the valuations on rival packaged foods companies ConAgra, Hershey, or Nestle, and you may quickly conclude that Kraft, at less than 18 times earnings, looks cheap relative to rivals who sell for P/E ratios of 18 and up. And yet, even if Kraft appears to be a relative bargain, viewed on its own merits the stock still looks overpriced.

Most analysts who follow Kraft agree that the company is unlikely to be able to increase its profits any faster than about 6% per year over the next five years. 17.7 times earnings seems a high price to pay for such snail's-paced growth, even if Kraft does pay a 4% dividend.

Investors also need to keep in mind that the profits Kraft does report may not be as valuable as they appear. Trailing free cash flow at the company amounted to only about $1.6 billion over the past 12 months. That means that for every dollar of "profit" the company claims to be earning, it's actually collecting only about $0.83 in real cash earnings.

Factor into the mix a debt load of $8.8 billion net of cash, and Kraft doesn't look like such a big bargain after all.

Does DDD spell "profit"?
Next up on Wall Street's buy list is three-dimensional printing pioneer 3D Systems (NYSE: DDD  ) , a perpetual favorite of the go-go momentum trading crowd. Initiating coverage of the company, and its two main rivals Stratasys (NASDAQ: SSYS  ) and ExOne (NASDAQ: XONE  ) as well, investment banker Pacific Crest declared 3D the best in the business, and likely to grow faster than its peers.

3D is popular here at the Fool as well. My own Foolish colleague Tamara Rutter, for example, recently pointed out that this year alone, 3D has "introduced four printer products, nine ProJet models, and two new consumer focused printers called Cube and CubeX." According to, Pacific Crest agrees that 3D's "diverse 3D printing ecosystem" is a positive, and the analyst likes the company's aggressive focus on "innovation" as well.

Personally, I'm inclined to agree with 3D's fans. From a financial point of view, the stock is the best in the business, generating not just positive free cash flow, but free cash flow that actually exceeds its reported net income. 3D racked up more than $46 million in cash profits over the past year, compared to the nearly $10 million in cash burned at Stratasys, and the $24 million in negative free cash flow at ExOne.

Mind you, I wouldn't go quite so far as to recommend actually buying the stock, as Pacific Crest does. 3D's P/E ratio, and price to free cash flow ratio, both exceed 160 today. Even at a projected annual growth rate of 24%, that's a very steep premium investors are being asked to pay to own the "best in class" 3-D printer maker. But as far as agreeing with the analysts that 3D is the best investment among a badly overvalued bunch? That much, I'll agree with.

Running away from Ingersoll-Rand
Finally -- and with apologies for ending on a down note -- we come to Ingersoll-Rand (NYSE: IR  ) , the subject of a downgrade to neutral at MKM Partners today.

MKM starts out by praising Ingersoll for being one of its "favorite names over the past 2 years." Exudes the analyst: "[Management] has delivered solid margin expansion and returned capital to shareholders ahead of a meaningful recovery in its primary end markets."

That said, MKM notes that with Ingersoll's recovery now complete, and its Allegion subsidiary spun off, the valuation of Ingersoll stock today appears "fair" -- and the 46% run-up the shares have enjoyed over the past year is unlikely to repeat. But is MKM pulling the plug too soon?

Perhaps. Most analysts, after all, still believe Ingersoll capable of growing earnings at 16% annually over the next five years. That's pretty substantial growth. And even if 21 times earnings seems like a high price to pay for it, consider: Ingersoll's free cash flow number for the past year ($1.1 billion) is 38% more than its reported net income ($807 million). This suggests the stock might be cheaper than it appears.

Long story short, at a price to free cash flow ratio of less than 15, but with a growth rate of 16% -- and a 1.2% dividend kicker -- I think Ingersoll-Rand still has gas left in the tank. I wouldn't necessarily be in a hurry to sell it on MKM's say-so.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends 3D Systems, ExOne, and Stratasys. The Motley Fool owns shares of 3D Systems, ExOne, and Stratasys and has the following options: short January 2014 $20 puts on 3D Systems.

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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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