Thursday's Top Upgrades (and Downgrades)

Analysts shift stance on Sony, Verizon, and Cree.

Feb 27, 2014 at 12:54PM

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 each of Sony (NYSE:SNE) and Verizon (NYSE:VZ). But the news isn't all good. Before we get to those two, let's take a quick look at why one analyst is...

Kicking Cree to the curb
We begin our review of today's ratings changes with Cree (NASDAQ:CREE). This morning, Piper Jaffray removed its "overweight" endorsement for the LED lighting specialist, downgrading the shares to "neutral" and setting a $67 price target. (The shares currently cost just under $63 apiece.) Details on the downgrade are hard to come by at this time, but we can still take a look at the numbers, to see if it makes sense.

With $1.2 billion in the bank and not a lick of debt, Cree sports a solid balance sheet. That said, at a P/E ratio of 65 times earnings, the stock certainly doesn't look cheap after its recent 12-month, 35% run-up in price.

Free cash flow has historically been a strong point for Cree, usually outpacing reported GAAP net income. It remains so today, with $144 million in trailing cash profits exceeding $117 million by about 23%. That said, even $144 million only gets Cree down to about a 53 times price-to-free cash flow ratio -- or 42 times valued using enterprise value. With most analysts positing an 18% long-term growth rate on the stock, even the most generous view of Cree's valuation, the EV/FCF ratio, tells us the stock is probably overpriced. Piper Jaffray is right to downgrade it.

Sony a star?
Moving on now to the stocks Wall Street likes, we find Citigroup upgrading shares of Sony Corp. to "buy." Sony, as you may have heard, announced plans yesterday to lay off 5,000 workers around the world, including 1,000 in the U.S. The company will also shut down 20 of its 31 U.S. retail stores in a move to cut costs, sell off its personal computer business, and spin off its flat-screen TV business as well.

Citi evidently likes the restructuring, and I do, too. Here's why:

Priced under 16 times earnings today, Sony looks attractively priced based on the 17% growth rate that Wall Street assigns it. The stock looks even cheaper when you consider that Sony is currently generating free cash flow ($1.9 billion) at nearly twice the pace at which it reports net income ($1 billion). I think of Sony less as being a "16 P/E stock," and more as being a stock that sells for 9.5 times free cash flow. If the company can hit 17% growth at this valuation -- or even half that growth rate -- then Sony is cheap.

Now, factor in the fact that Sony is freeing up extra cash in the short term as it exits money-losing ventures such as TVs, and the immediate picture looks even better for Sony. Long story short, Sony is cheap as is. It could turn out to be even cheaper after the restructuring.

Better views of Verizon, "two"
Last and far from least, we come to telecom behemoth Verizon, which this morning is enjoying dual endorsements from two companies named "Morgan" -- Morgan Stanley, which is resuming coverage of the stock with an "overweight" rating, and JPMorgan Chase, which just now added the stock to its "Focus List" of enthusiastically recommended stocks.

Morgan Stanley says the stock will soon be worth $52. JP thinks it could hit $57 within a year. For a stock sitting below $47 at present, these are some optimistic assumptions -- anywhere from a 10% to a 20% profit, plus a further 4.6% worth of dividends -- for buyers today. But are these promises realistic?

I think so. Priced at less than 12 times earnings today, but pegged for a strong growth rate near 10% over the next five years, Verizon shares look admirably priced for profit. The more so when you consider that with $22.2 billion in free cash flow generated over the past year, Verizon is actually close to twice as profitable as its $11.5 billion net income number makes it appear.

Result: Whether I valued the stock on GAAP earnings or on free cash flow, any way you cut it, Verizon is a cheap stock -- and fully deserving of its multiple buy ratings today.

Rich Smith has no position in any stocks mentioned, and neither does The Motley Fool.

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