This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, some of the most interesting ratings on Wall Street are coming out of just one single stock shop -- investment banker RBC Capital Markets. We'll be looking at two of its tech downgrades, Teradata (NYSE: TDC ) and Oracle (NYSE: ORCL ) today. But first, let's check out one stock that RBC actually likes.
Accenture (NYSE: ACN )
Christmas came early for Accenture shareholders this morning, when RBC initiated coverage of the consulting firm with an outperform rating and a $88 price target. Probably the world's premier IT consulting firm, it's easy to see why RBC might want to recommend Accenture to "outperform" the market over the next year. There's just one problem: it probably won't. Not from this price point, at least.
Selling for $74 and change, Accenture shares already cost more than 15 times earnings. This seems a "fair" price to pay for the company's 12% projected growth rate, and 2.5% dividend yield. However, unlike in years past, when Accenture was known as a powerhouse producer of cash, lately, the company's free cash flow engine has been having some hiccups.
Free cash flow for the past 12 months came to just $2.9 billion -- more than 10% below the company's claimed $3.3 billion in GAAP "net income." Valued on this free cash flow, the firm's selling for more than 16 times earnings -- even worse than the P/E. Long story short, while it's certainly not the most overvalued equity on the market today, I just don't see enough value in the stock to justify a buy rating. I think there are better bargains out there.
Bargains like... Teradata?
Interestingly enough, I also disagree with RBC's decision to downgrade shares of Teradata. This morning, RBC pulled its outperform rating from the data warehousing firm, reducing its recommendation to only sector perform and assigning a $41 price target. This looks like a mistake.
Sure, on the one hand, I get why RBC might be fed up with Teradata by this point. The stock's underperformed the market by nearly 60 full percentage points over the past year, and lost 33% of its market cap. But this significant price underperformance in the past sets up the stock for a brighter future.
Priced today at 17.5 times earnings, Teradata produces so very much free cash flow from its business that it scores a low, low 12.6 ratio on the P/FCF meter. That's below Teradata's level of anticipated profits growth, where analysts are predicting the company will grow at a 12.7% clip over the next five years. In most years, this would work out to what I'd call a "fair valuation" on the stock -- a slight discount to fair value at best. But in today's overheated market, I think it makes Teradata look like a relative bargain... relative to pretty much any other stock I look at.
Do you believe in Oracle?
Actually, make that "any other stock" but one: Oracle. Oracle is the other tech stock getting hit by a downgrade from RBC today. Citing competition from cloud computing companies and novel ways to organize and mine data, RBC removed its outperform rating from Oracle, and assigned it, too, a sector perform. (In related news, Morgan Stanley also chose today to downgrade the stock.)
And yet, once again I think the analysts are being too harsh on this tech stock. Selling for a mere 14.5 times earnings today, Oracle is the cheapest of the three stocks that RBC commented on today. It's cheaper still, when valued on its $14.2 billion in free cash flow, and given fair credit for its $15 billion in net cash reserves.
I calculate an enterprise value-to-free-cash-flow ratio of barely 10.1 on Oracle stock today. With even the most pessimistic analysts agreeing that Oracle will probably be able to maintain 10%-plus earnings growth over the next five years, and with Oracle continuing to pay a respectable 1.4% dividend yield, I think the stock offers a pretty compelling bargain.
And if Oracle surprises us, and grows at something closer to its historical pace of 18% earnings expansion? In that case, the stock could turn out to be a real steal of a deal.
Motley Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Accenture and Teradata. The Motley Fool owns shares of Oracle.