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 big downgrades for WisdomTree Investments (NASDAQ: WETF ) and Orbitz (NYSE: OWW ) , both now rated sell. On the bright side, though, one analyst believes that...
ITT is a great investment
Wednesday dawned bright for shareholders of ITT Corp. (NYSE: ITT ) as the industrial conglomerate won a new "buy" rating and a price target of $50 a share from SunTrust Robinson Humphrey. With shares trading around $43.50 this morning, SunTrust's prediction equates to a promise of 15% profits from the shares themselves, plus a tidy dividend yield of 1.1%. But will investors truly receive these riches?
Maybe, maybe not. On the one hand, valued at more than eight times earnings, ITT shares look attractively priced relative to consensus analyst estimates of 13% long-term earnings growth. The company boasts a rock-solid balance sheet with nearly $580 million in net cash. And, of course, there's that dividend working in ITT's favor as well.
My main concern with the stock is that, while historically a strong cash producer, ITT's latest 12 months' results show free cash flow taking a turn for the worse. Total cash profits for the past year came to just $87 million -- a mere fraction of the $488 million in "earnings" the company reported under GAAP accounting standards. This suggests that ITT's low P/E ratio may not be quite as cheap as it appears.
Valued on free cash flow, the stock trades for a hefty 45-times multiple, which is probably too much for its 13% growth rate to support. My hunch: The 1% rise in stock price that ITT shares are enjoying in response to today's upgrade offers investors a perfect chance to take their profits and exit ITT.
Falling out of Orbitz
Speaking of apparently cheap stocks that really aren't -- Orbitz.
Shares of this travel reservations website cost only $8 and change this morning and sell for a P/E ratio that looks just as cheap as that price sounds -- less than six times earnings. That sounds like a fair price to pay for Orbitz's anticipated 6% long-term growth rate. But there are good reasons to question the valuation on this stock as well. Free cash flow at the firm came to just $114 million over the past 12 months, or just $0.69 for every $1 of claimed GAAP earnings.
Valued on free cash, the stock sells for closer to an eight times multiple, or an enterprise value of 11.5 times free cash flow, once you take the company's net debt into consideration. If 6% is all the growth Orbitz can muster, these valuations may well prove to be too much to pay for the stock.
Worse, according to Goldman Sachs (which downgraded Orbitz to "sell" this morning), even 6% growth could turn out to be a stretch for Orbitz. According to the analyst, Orbitz has an incrementally higher risk profile due to slowing growth as it annualizes its white label agreement with American Express... its exclusive Kayak relationship [expires], and... its new loyalty program" costs it additional money.
When you consider that even the viewed under the kindest light, Orbitz shares are only fairly valued on 6% growth and a 6 P/E -- and that the other ways of valuing the company all show it to be expensive -- any diminution in the growth rate could become the straw that breaks the bull's back. Goldman is right to downgrade it.
WisdomTree cut off at the roots
Last and least, we come to asset manager and exchange-traded fund seller WisdomTree. Citi is advising investors to sell it this morning, highlighting stock sales by insiders, and warning that WisdomTree's success depends largely on the popularity of its WisdomTree Japan Hedged Equity (NYSEMKT: DXJ ) ETF, which turned out to be very popular with investors looking to hedge the risk of a declining yen in 2013.
Citi thinks this trendy ETF's attraction will wane, however, and warns that with 35% of the company's assets under management being invested in it, there's an "asymmetric risk" to the stock should this one single product lose even a sliver of its popularity. Other analysts disagree, though, with the average analyst still predicting that WisdomTree to grow earnings at close to 25% annually over the next five years, according to S&P Capital IQ.
Even if Citi's wrong and they're right, however, this may not bode well for WisdomTree shareholders. The stock trades for a steep 36 times earnings multiple. At that price, even 25% growth may not be enough to keep the stock price on this Tree growing.