Wednesday'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 downgrades for both online marketer ReachLocal (NASDAQ: RLOC  ) and milk maker Dean Foods (NYSE: DF  ) -- but the news isn't all bad. Before we get to those two, let's start on a bright note with a few words on...

TripAdvisor's trippy quarter
Shares of online travel agent TripAdvisor (NASDAQ: TRIP  ) are soaring this morning, up more than 8% on news that the company met analyst earnings estimates of $0.21 per share last quarter, and beat revenue expectations with a stick.

TripAdvisor CEO Steve Kaufer characterized his company's 2013 performance as strong, with more than 2 billion unique visitors patronizing the website. Business was especially brisk in Q4, with TripAdvisor pulling down $212.7 million in revenue versus a consensus estimate of only $205.8 million.

The good news is getting rave reviews on Wall Street, as RBC Capital upgraded the shares to outperform today, and set a new price target of $95 (up from $68). Quoted on this morning, RBC praises TripAdvisor's revenue growth acceleration, and in particular the growth in revenues from advertising (up 26%) and vacation rentals (nearly twice as fast).

Numbers like these suggest that consensus expectations for TripAdvisor's earnings growth -- 19% -- could be on the conservative side. Problem is, they'd have to be really, really conservative to justify this stock's valuation. Priced at 62 times earnings today, or even a seemingly cheaper 44 times free cash flow, the stock still looks richly priced.

While this doesn't detract from the strong performance reported yesterday, I'm still of the opinion that this is a case of "great company, too-expensive stock." I'd be looking at today's price strength as an opportunity to take profits, and wait for a better entry point to get back in.

ReachLocal can't catch a break
Speaking of stocks that are too expensive: ReachLocal. Like TripAdvisor, ReachLocal reported earnings yesterday, and like TripAdvisor, it exceeded expectations -- but backward. At ReachLocal, it was earnings that exceeded estimates ($0.05 per share earned in Q4, versus $0.03 predicted), while revenues fell a bit short.

Analysts are not responding at all well to the news, with at least three having issued downgrades at last report -- JPMorgan, Needham & Co., and Craig-Hallum. All three now rate ReachLocal the equivalent of a hold. Needham provided the most color today, noting that ramping sales in H2 2014, as ReachLocal hopes to do, "may be a challenge." Meanwhile, the company's plan to realign its sales force "reduces near-term revenue growth."

When you consider that ReachLocal is currently not a profitable operation, it follows that its valuation must hinge on the company's future prospects. Analysts expect earnings to grow at about 27% annually over the next five years. But now, Needham is saying that sales, at least, will be growing slower than expected -- which implies slower growth in earnings as well. With the growth thesis in peril, and no current profits to value the company on, the analysts are probably right to be cautious.

Flunking Dean Foods
Finally, we come to dairy company Dean Foods, which -- you guessed it -- also reported earnings yesterday. Like the others, this one was a mixed bag: Q4 profits missed analyst expectations by a penny, coming to $0.18 per share when $0.19 was expected. Revenues slightly exceeded expectations -- $2.3 billion versus $2.27 billion.

The big news at Dean Foods, though, was that the company paired its earnings report with an earnings warning for 2014. Dean believes that when the year wraps up, it will have earned somewhere between $0.73 and $0.86 per share. Problem is, analysts were hoping to see $1.12. The discrepancy is big enough to move Dean Foods' forward P/E ratio up from the 12.4 times that we thought it was selling for before the warning, to about 17.5 times based on the new guidance.

Now, 12.4 times earnings might have been an acceptable valuation on a stock like Dean, which pays no dividend, but is expected to notch nearly 12% earnings growth over the next five years. On the other hand, 17.5 times earnings is a bit rich. Taking a fresh look at the valuation picture today, Stifel Nicolaus has decided to pull its buy rating from the stock, and disavow its former price target ($22) as well. At today's updated valuation, I think Stifel's making the right call.

Rich Smith has no position in any stocks mentioned, and doesn't always agree with his fellow Fools. Case in point: The Motley Fool recommends both ReachLocal and TripAdvisor. 


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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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9/3/2015 4:00 PM
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