Tuesday'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 headlines feature new buy ratings for Plum Creek Timber (NYSE: PCL  ) and Toyota  (NYSE: TM  ) -- and we'll get to both of those in a minute. But first, a few words on...

Apple's expectations miss
As you've no doubt heard by now, Apple (NASDAQ: AAPL  ) reported earnings last night, and investors are not pleased. iPhone sales missed targets, and Apple is promising to generate significantly less revenue this quarter than Wall Street had hoped. In response, the Street is rushing out downgrades, and Apple shares are falling like a rock.

I think that's a mistake.

So far, Oppenheimer and Raymond James have both downgraded the stock -- to perform and (curiously) outperform, respectively. Price targets have been cut at Jefferies, Goldman Sachs, Nomura, Needham, and ... need I go on?

And yet, when you look at the stock objectively, it's hard to avoid the conclusion that Apple is an astonishingly good value at today's post-sell-off pricing. Earnings and free cash flow are both down, true. Yet Apple still generated $45.1 billion in positive free cash flow over the past 12 months. That means the stock is now trading for just a hair more than 10 times free cash flow, even if you give the company no credit at all for its $23.6 billion in net cash on the balance sheet. The stock is incredibly cheap at analysts' consensus target of 15% annualized earnings growth for the next five years. And indeed, with a 2.2% dividend to its credit, Apple is probably "buyable" if growth is even half that rate.

I owned Apple before yesterday's "disappointment" -- and I'll probably buy more as soon as the  Motley Fool's disclosure policy permits.

Pumping Plum Creek
Turning now from a company that missed expectations yesterday to one that beat them -- and is getting rewarded for its victory -- we find tree harvester Plum Creek Timber winning an upgrade to buy from DA Davidson. Plum Creek reported $0.31 per share in fourth-quarter profit Monday, versus analysts' expected $0.29. Revenue also exceeded expectations, while the current year's guidance calls for earnings not too far off from expectations -- $1.30-$1.50 per share.

All of this adds up to a target price of $50 in Davidson's book, or about a 14% profit from today's prices on Plum Creek shares. Add a 4.1% dividend to that, and today's buyers could be looking at a very tidy profit a year from now.

Or not.

Looking at Plum Creek's stock today, I can't get around the fact that despite generating significantly more cash profit from its business than it reports as net income, Plum Creek nevertheless sells for an enterprise value 41 times its free cash flow, with a projected 3% growth rate. Even admitting that free cash flow is a "lumpy" figure, ebbing and flowing over the years, Plum Creek's average rate of cash production over the past five years was still only $313 million. At today's prices, that still yields an enterprise value of 33 times its average annual cash production -- which seems far too much to pay for 3% growth, even with the 4.1% dividend.

In short, while it's certainly possible that Davidson is right and Plum Creek shares are bound to rise, I would not bet on that.

Revving up Toyota
Finally, we come to Toyota. Yesterday, we learned that U.S. safety regulators are looking into complaints about faulty brakes in Toyota Camry gas-electric hybrid cars, a potential disaster for the company's booming hybrids business. Given this news, now seems like an unlikely time for analysts to upgrade the stock. Yet UBS today bumped Toyota up to buy.

Then again, maybe UBS is right to be optimistic. Priced at just 10.4 times earnings today, Toyota stock actually sells for a lower P/E ratio than do Ford, GM, and Honda. Yet the 34% projected annual growth rate in Toyota earnings is faster than any of its rivals can boast. True, free cash flow at Toyota is no great shakes -- only $7.5 billion for the past year, versus reported income of $14.4 billion. But even so, that works out to a price-to-free cash flow ratio of 25, which is still comfortably below the projected growth rate.

With a respectable 2.1% dividend yield, cheap share price, and strong anticipated growth, Toyota stock may well turn out to be every bit the buy that UBS says it is.


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