Tuesday'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 (yet another) upgrade for Yelp (NYSE: YELP  ) and a new one for Siemens (NASDAQOTH: SIEGY  ) . But the news isn't all good. Before we tackle those two, let's take a quick look at why one analyst is...

Downgrading American Eagle Outfitters (NYSE: AEO  )
Shares of teen clothier American Eagle Outfitters were leading the market down this morning, off 0.6% in response to a downgrade from analysts at Janney Montgomery Scott.

Why? According to Janney, American Eagle suffers from "excess inventory overhang" that will "pressure margins in 2Q14" as the company is forced to cut prices to clear out stale styles from its stores. AE's denim and tops assortment "misses the mark" on style, according to Janney, and with customers less than enthused about buying the product on its own merits, the company's going to have to compete on price -- with a negative effect on profits.

Janney notes that American Eagle is looking to earn about one-third less profit this year ($0.40 per share) than previously promised ($0.59), while next year's earnings will be lucky to hit $0.50 -- less than AE was formerly expected to earn this year. Consequently, the analyst thinks the stock's worth only about $10 (20 times earnings two years out).

The strange thing about this rating, of course, is that AE shares currently cost $11.61 -- 16% more than Janney thinks they're worth. Yet the analyst is only downgrading AE shares to "neutral," and not "sell."

I think that's a mistake. At a current valuation of 27 times earnings, and with a cash flow statement confirming that American Eagle is now burning cash, this stock is even more expensive than it looks, and no longer deserves a place in your portfolio.

More help for Yelp 
Turning now to the stocks that Wall Street actually likes, we begin with Yelp -- the subject, as you may recall, of an upgrade to "outperform" by Oppenheimer just yesterday. This morning, investment bankers at SunTrust seconded that emotion, upgrading Yelp to "buy" and assigning the stock a $100 price target.

Notes SunTrust: "Yelp stock is down 33% in the past month, the worst performer in our basket of 20 mid and large cap Internet peers," and a victim of "the broader market correction, punishing high growth, high multiple, top performers like Yelp." SunTrust thinks this sentiment is due to change, and wants to get into the stock to ride it back up when Yelp ultimately bounces.

Well and good. But while SunTrust's opinion of Yelp's stock may have changed, the facts about the stock have not.

Yelp remains a deeply unprofitable company, generating meager free cash flow ($5.2 million annually) and selling for well over 900 times annual cash profits production. Even crediting the company for GAAP profits it might (or might not) earn next year, the stock costs 190 times forward earnings, and is vastly overpriced even for its promised 43% earnings growth rate. Yelp stock may one day fall low enough to make the stock a bargain -- but that day has not yet come, and SunTrust's jumping the gun when it tells you otherwise.

Seeing potential in Siemens
So where should investors look for bargains? According to Merrill Lynch, one good place to start might be overseas, in Germany. This morning, B of A's investment banking subsidiary upgraded shares of Germany's Siemens from "neutral" to "buy."

Valued at a market capitalization of $113.9 billion, Siemens reported $6.2 billion in GAAP earnings last year, yielding a P/E ratio of just 18.4. But the stock's even cheaper than it looks. With $8.4 billion in positive free cash flow produced during the same period, its P/FCF ratio works out to a mere 13.6. For a stock expected to grow its profits at close to 13% annually over the next five years, and paying a tidy 2.2% dividend yield, that puts Siemens shares firmly in value territory.

Granted, a stolid industrial stock like Siemens lacks the potential to generate the multibagger returns possible from a successful turnaround story like American Eagle. It lacks the go-go growth rate of (currently profitless) Yelp as well. Yet for value investors, after reviewing the three stocks featured in today's column so far, I think Siemens looks like the best value by far.

Motley Fool contributor 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 Yelp.

 


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