Friday'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 upgrades for mini-industrialist Stratasys (NASDAQ: SSYS  )  and for remote computer access specialist LogMeIn (NASDAQ: LOGM  ) but a downgrade for publicly traded soccer club Manchester United (NYSE: MANU  ) . Let's take them one at a time, beginning with...

A seesawing upgrade for Stratasys
Investment banker William Blair's upgrade of Stratasys this morning to market perform starts out sounding pretty optimistic, with allusions to new product launches and business partnerships, "continuing strength in the core business, successful integration of Objet, [and] potential upside to revenue expectations for MakerBot."

It goes down swiftly from there.

Quoted on StreetInsider.com this morning, Blair predicts 20% earnings-per-share growth at Stratasys over the next several years, starting high at 25% in 2014 and tapering afterwards. But the problem with Stratasys remains the stock's valuation. A growth of 20% or 25% implies that a fair valuation for the stock might be somewhere in the mid-20s for P/E as well. But as Blair points out, "[At] $118, shares of Stratasys trade at 54 times our 2014 adjusted EPS estimate of $2.20."

This alone should warn you that the valuation is too rich. By the time Blair reaches its warning that "30 to 35 times [is the] average multiple associated with technology companies that we perceive to have growth, margin, and return profiles similar to Stratasys," it should be clear that 54 times is too high a price to pay. When you further consider that Stratasys is not currently generating any free cash flow whatsoever -- that it's been burning cash for two years straight in fact -- the only question that remains is why William Blair decided to upgrade the stock at all.

Time to LogMe (back) In?
A similarly optimistic write-up for LogMeIn suffers from a similar logic gap. Yes, LogMeIn reported an earnings beat yesterday, topping consensus estimates for Q4 earnings by a penny. Yes, management says that earnings and revenues will exceed expectations in Q1 2014, and for the full-year 2014 as well. But does all of this justify the 26% spike in share price we're seeing today or the upgrade to buy that Needham & Co. just assigned to LogMeIn?

I don't think so, and I'll tell you why not.

LogMeIn's earnings news yesterday has the company losing nearly $8 million for fiscal 2013. Things should improve in the New Year, of course. And already, LogMeIn is generating positive free cash flow at the rate of $19 million annually.

One problem here, though, is that after today's stock surge, LogMeIn shares sell for the Stratasys-like valuation of 53 times free cash flow. (Lacking GAAP profits, LogMeIn has no "P/E.") Given that LogMeIn's projected earnings growth rate isn't any higher than Stratasys's (it's actually about a percentage point lower, according to Yahoo! Finance data), the logical conclusion is that if Stratasys is overvalued, then LogMeIn must be, too.

Needless to say, Needham disagrees with this assessment. Arguing that LogMeIn's forward guidance is "conservative," Needham thinks there's another $6 -- or 14% worth of profits -- left in the stock, and has a $48 price target on LogMeIn shares. However, given the outrage voiced by the company's customers last month over a ham-handed demand that users of its Ignition software pay license fees within seven days or get kicked off the service, and the continued availability of free alternatives for logging into computers remotely, I'm not as optimistic that the company will succeed in its attempt to monetize its software. I'm certainly not optimistic about the stock's valuation -- and won't be following Needham's advice to buy the shares.

Manchester United -- rejected!
British football club Manchester United reported a small earnings beat on Wednesday, earning 12 British pence in its fiscal second quarter. That was flat against year-ago earnings but a penny ahead of estimates and on much stronger revenues as well.

Regardless, the team's inability to improve earnings despite strong revenue growth appears to have discouraged Raymond James. This morning, the investment banker removed its price target from the stock and downgraded Man-U to market perform. Is that the right call?

It's hard to say. Valued on GAAP earnings Manchester United shares sell for less than 12 times earnings, which hardly seems a high price to pay. The real problem with Manchester United, though, is that it's producing exceedingly weak cash profits. Free cash flow for the past 12 months came to just $84 million -- quite a bit less than is claimed on the income statement. Also, the company's ability to grow earnings is very much in question. It didn't grow at all last quarter, after all. Yahoo! Finance estimates suggest earnings might not grow much at all over the next five years, either.

If there's any upside to be found in this story, it's the fact that analysts quoted on S&P Capital IQ see a significantly brighter future for the soccer club, and predict rapid earnings growth of 28% annually on average, over the next five years. If they're right, the stock's still a bargain at today's price. If they're wrong, though, then the stock's a dud -- and Raymond James is right to downgrade.

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 and owns shares of Stratasys.


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