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 feature downgrades for both Manchester United (MANU 1.48%) and Mercadolibre (MELI -1.01%). On the brighter side, though...
Honeywell just got upgraded
The good news today is that after reporting strong earnings late last week, Honeywell International (HON 1.66%) is getting its reward today in the form of an upgrade from analysts at equity research firm Langenberg & Co.
On Friday, Honeywell reported growing its sales by 4% in 2013 and its profits eight times more -- up 33% year over year to $4.92 per share. Better still, Honeywell experienced especially strong growth in the fourth quarter of the year, setting up the company for continued growth in 2014. It's that last bit that caught Langenberg's notice.
Quoted on StreetInsider.com this morning, Langenberg observes that right now, what "the market wants [is] a) accelerating revenue growth, b) great managements and c) execution. That would be HON ... the entire portfolio is positioned for continued revenue momentum and 10% annual EPS growth for the next two years."
To an extent, I agree. Honeywell is producing strong, relatively consistent growth -- but that's not the problem. The problem with Honeywell, quite simply, is that it costs too much. At a valuation of 18 times earnings and 20 times free cash flow, 10% growth just doesn't cut it. According to Langenberg, this valuation is OK given that "almost everything is bid up [in] the market." But just because everyone else is overpaying for equities these days doesn't mean that you should, too.
A better way to play
Curiously, it may be our first downgrade of the day that offers you a better way to play today's overvalued market. This morning, analysts at Deutsche Bank cut their rating for publicly traded soccer club Manchester United to "hold." According to Deutsche, the cost of hiring players is likely to be higher than it had previously counted on, suggesting earnings will be lower than it had hoped.
For example, Spanish midfielder Juan Manuel Mata García was recently signed for a "club record fee," and Deutsche fears that Man U intends to "further invest in players to improve performance." So while Deutsche says it still sees "compelling growth over the next several years as MANU continues to unlock brand value," it's tempering its optimism over the risk of higher costs.
I disagree. Although at a valuation of 25 times free cash flow, Manchester United is not an obviously "cheap" stock, it does have its attractions. For P/E-focused investors, for example, the stock's selling for less than 12 times earnings, a price certain to attract at least some value investors. Meanwhile, for the growth crowd, analysts (other than Deutsche) are expecting earnings growth at the company to exceed 30% annually over the next five years -- making the stock look like a bargain, whether valued on earnings or free cash flow.
Arriba! Arriba! Mercadolibre
Speaking of fast-growing earners that Wall Street is turning negative on: Mercadolibre. This morning, the "Latin American eBay" got downgraded one notch from "neutral" to "underperform" at Merrill Lynch, after host country Argentina devalued its peso last week. Mercadolibre shares are down about 11% since the devaluation was announced, but apparently, Merrill thinks they'll fall even more -- and it may be right.
Sure, on the one hand, the stock is a bit cheaper today than it was last week. The question, though, is whether it's cheap enough. After all, even today's valuation of 39 times earnings seems no great bargain on the 27% earnings growth that Wall Street expected pre-devaluation. When you notice, too, that Mercado's free cash flow lags reported earnings by $98 million FCF to $107 million net income, you have to wonder if even the profits that the company is earning are of very high quality.
Personally, I'd rather err on the side of caution with this one. Counting on fast growth in a troubled economy, and paying a premium for the hope that this growth will pan out, doesn't sound sufficiently cautious to me -- and so I'd stay away from Mercadolibre.
Fool contributor Rich Smith has no position in any stocks mentioned -- and his opinions don't always align with those of The Motley Fool. The Motley Fool recommends MercadoLibre. The Motley Fool owns shares of MercadoLibre.
