Tuesday's Top Upgrades (and Downgrades)

Analysts shift stance on Michael Kors, lululemon athletica, and Netflix.

Jan 7, 2014 at 1:23PM

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'll be focusing on popular consumer brands Michael Kors (NYSE:KORS) and Netflix (NASDAQ:NFLX), both of which have suffered downgrades, and lululemon athletica (NASDAQ:LULU) -- which scored a rare upgrade this morning. In fact, let's start with that one.

LULU is no lemon
Shares of yoga-wear maker Lululemon are leading the market up this morning after receiving an upgrade to "buy" from analysts at D.A. Davidson Tuesday. Citing the potential for growth to reignite as the company gets past its see-through pants problems, combined with the company's inarguable market leadership and a more attractive valuation, Davidson says we could see Lululemon shares hit $73 within a year.

But is Davidson right?

With its stock down nearly 20% over the past year, against a 25% gain for the S&P 500, Lululemon is definitely cheaper than it has been. Yet the stock still sells for 31 times earnings, which appears expensive in light of expected 18% long-term earnings growth. Worse, free cash flow at the company ($169 million) continues to lag behind reported GAAP earnings ($279 million) -- resulting in an even less attractive price-to-free cash flow ratio of 50.

Result: While it would be nice to imagine that Lulu's troubles have made its stock a bargain that can be taken advantage of, the truth of the matter is that its shares were so vastly overvalued before the scandal struck that, even in its aftermath, the stock remains overpriced. Davidson is wrong to recommend buying Lululemon.

Of Kors, it's overpriced!
Keeping our focus on highly sought-after consumer goods for a bit, we turn now to fashion accessories manufacturer Michael Kors -- just downgraded to neutral by Citigroup. According to StreetInsider.com, which reported the rating this morning, Citi's worries center on Kors' watches business. Citi notes that retailer Macy's experienced weak sell-through in watches in Q3, while Fossil, which specializes in watches, says it's experiencing sluggish traffic and is having to cut prices (and profit) margins to move inventory.

These trends have Citi feeling cautious about Kors' valuation after the stock's 60% runup in 2013. And rightly so.

Priced at 32 times earnings, Kors shares carry a valuation similar to that found at Lululemon. Growth expectations at the company (25% over the next five years) haven't taken as much of a hit yet. But after examining the company's cash flow statement, I can't help but wonder if people shouldn't perhaps be more worried about Kors than they are about Lululemon.

After all, Kors generates barely half as much free cash flow as the company's GAAP income statement suggests -- just $272 million in cash profits generated over the past year, versus reported "income" of $502 million. As a result, the stock's price-to-free cash flow ratio sits north of 59, which is almost certainly overpriced even if the company does achieve 25% growth. Given this, Citi is right to be cautious about the stock, and right to downgrade it.

The granddaddy of overpriced momentum stocks
And speaking of overpriced stocks: Netflix. Popular though the company's services may be, at 287 times earnings, they sell for a very pretty penny indeed. Far more than even its projected 22.5% annualized earnings growth rate (which is 2.5 points behind Kors', by the way) could possibly justify. Far, far more than the stock is worth, given that Netflix currently generates no free cash flow whatsoever.

Viewed in the most favorable light, Netflix's free cash flow for the past year was negative $10 million -- negative $40 million, once you factor in the costs of keeping Netflix supplied with DVDs for its rent-by-mail service. Little wonder, then, that this morning analysts at Morgan Stanley cut the stock's rating to "underweight" (meaning "sell").

Morgan justifies its tardy downgrade of Netflix -- the shares have actually been overpriced for quite some time -- by saying that it's just now noticed that "viable alternatives" to Netflix's streaming service have emerged in the form of Amazon Prime Instant Video, HBO Go, and Hulu Plus. But, honestly, I don't think there's any need to strain for a justification here. Netflix's on-its-face overvaluation is more than reason enough to sell this stock.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Fossil, lululemon athletica, Michael Kors Holdings, and Netflix. The Motley Fool owns shares of Netflix. 

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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