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Thursday's Top Upgrades (and Downgrades)

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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 upgrades for oilfield services companies Schlumberger (NYSE: SLB  ) and Halliburton (NYSE: HAL  ) . But the news isn't all good. Before we get to those two, let's take a quick look at why analysts are...

Souring on Citrix
Last week, as you may recall, remote computer access software company LogMeIn (NASDAQ: LOGM  ) got walloped after alienating its customer base with a bungled switch from "free" software usage to a new "pay up in seven days, or get locked out" policy. This morning, rival remote access provider Citrix Systems (NASDAQ: CTXS  ) is getting punished even harder, albeit for a different reason.

Citrix reported Q4 and full-year 2013 earnings yesterday, with profits per share of $1.04 beating analyst estimates soundly. Unfortunately, Citrix followed up this good news with bad: Fiscal 2014 earnings will probably come in around $2.90 per share, far below analysts' expected earnings of $3.35. And the numbers could be even worse than that. In Q1, analysts are looking for Citrix to earn about $0.69 per share, but Citrix now says it will be lucky to earn even $0.60, and could earn as little as $0.57. Percentagewise, this suggests the company sees Q1 results as being pretty awful, and will need to quickly improve in order to meet even its revised target for the full year -- which is no certainty at all.

Result: So far, no fewer than six separate analysts have cut their ratings on Citrix. Most say they fear the company will only match the market's returns at best, while JMP Securities has gone a step further and downgraded the stock to "market underperform." Oh, and the shares are down 9%, too. Can things get any worse than this?

They may. Based on Citrix's latest guidance, the stock appears to be selling for about 18 times the earnings it expects to make this year. That's pretty pricey for a stock that analysts thought would grow at only 13% annually before the earnings warning. Assuming growth now gets crimped, the stock is only going to look pricier.

Granted, free cash flow for the past 12 months has been strong, yielding a valuation of 13 times cash profits. But again, the growth rate is a concern. All things considered, I suspect the analysts are right to be cautious, here, and the downgrades and new "neutral" ratings are appropriate.

Banner days for oil investors
In contrast to the selling frenzy at Citrix, investors in the oil patch are enjoying a wonderful day thanks to new buy ratings for oilfield services stars Schlumberger and Halliburton from boutique investment banker Griffin Securities. Let's take these one at a time, starting with Schlumberger. 

Don't be a chump for Schlumberger
Priced at $89 today, Schlumberger stock will rise to $106 within a year, predicts Griffin. Between this prospect of a 19% capital gain, and Schlumberger's 1.8% dividend yield, investors can expect a better than 20% profit from buying today, according to the analyst. But is Griffin right?

Perhaps. On the surface at least, Schlumberger stock looks fully as attractive as Griffin says it is. The stock sells for only 17.5 times earnings, but it has a projected 18.5% projected growth rate. Its balance sheet looks strong, with less than $5 billion net debt on a $117 billion market cap. My one reservation about the stock is that two weeks after reporting its fiscal 2013 earnings, Schlumberger still has not released a cash flow statement informing investors of how much actual cash profit it's earning.

There could be a reason for this. Over the past five years, Schlumberger hasn't once generated real free cash flow better than (or even equal to) its reported net income. Chances are, 2013 was no different -- and Schlumberger is not as cheap as it looks... or as cheap as Griffin says it is, either.

Halliburton's no happier
Like Schlumberger, Halliburton stock is on the upswing this morning -- and like Schlumberger, it's probably the new buy rating from Griffin Securities that explains Halliburton's rise. The stock beat earnings soundly in its Q4 report last week, and Griffin seems to expect more good news in the year to come, predicting the stock will rise from its current price of $49 and change to hit $62 by year-end -- a 26% gain.

But just as with Schlumberger, this is a story likely to end in tears. Here's why.

Priced at 21 times earnings, Halliburton looks on the surface fully as attractive as Schlumberger, with a projected growth rate of 22% that makes the stock look like a buy. But if possible, the buy thesis for Halliburton appears to be loaded with even more caveats than we saw at Schlumberger. For one thing, Halliburton pays a worse dividend than its rival (1.2% to 1.8%). For another, it's more indebted than Schlumberger both relative to its smaller market cap, and as an absolute level of debt ($5.2 billion net of cash, versus Schlumberger's net debt of $4.8 billion).

Plus, while at this time we can speculate that Schlumberger's reported GAAP profit overstates its true level of cash profit, with Halliburton, we know for a fact that the quality of earnings is low. Free cash flow for the past year at Halliburton amounted to only $1.5 billion -- or only about $0.71 for every $1 in reported GAAP earnings.

Result: I calculate the stock's true enterprise value-to-free cash flow ratio at not the 21 multiple suggested by its P/E, but at a whopping 31. Maybe Griffin thinks this price is a fair one to pay for 21% growth. But I disagree.

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Rich Smith

As a defense writer for The Motley Fool, I focus on defense and aerospace stocks. My job? Every day of the week, I'm monitoring the news, figuring out the winners and losers, and tracking down the promising companies for you to invest in. Follow me on Twitter or Facebook for the most important developments in defense & aerospace, and other great stories.

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