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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, Wall Street has China on its mind as analysts announce new buy ratings for Qihoo 360 (NYSE: QIHU  ) and SINA Corp. (NASDAQ: SINA  ) , but...

A downgrade for microblogging service Weibo
Let's start with that one. This morning, analysts at Goldman Sachs initiated coverage of recent IPO Weibo (NASDAQ: WB  ) , which listed on Nasdaq last month. Debuting at an IPO price of $17, Weibo shares have gained nearly $3 since their advent, but Goldman thinks they could go up quite a bit more. At the same time, though, analysts from WallachBeth decided to downgrade the stock, removing their old buy rating and replacing it with a hold.

Which analyst is right?

Quoting from the write-up on this morning: "Weibo attracts a broad range of content that in turn attracts a growing number of users and content providers, driving a virtuous cycle that reinforces its position as China's leading social media platform. Revenue visibility is supported by major stakeholders Sina (through which it transacts with advertisers) and Alibaba (with which the company expects to generate US$380 mn in ad revenues over 2013-2015). Relative to Twitter, its user base is 54%, revenue 28%, and valuation 15% as of 2013."

So, in other words, Goldman sees Weibo as a smaller, cheaper Chinese version of Twitter (NYSE: TWTR  ) . That sounds good enough -- so why might WallachBeth be downgrading it?

Well, for one thing, Weibo resembles Twitter in other respects than just its business model. It's not profitable. S&P Capital IQ gives the company a gross profit margin in excess of 68%, but puts its bottom-line profit figure at negative 20%. (That's not as bad as the negative 94% profit margin at Twitter, but it's bad enough.) Weibo is also burning cash like its U.S. analog -- with free cash flow reported at negative $21.4 million for the past 12 months. Finally, if you value the stock on sales (since it has no profits), Weibo isn't even all that cheap relative to Twitter. Its price-to-sales ratio stands at 21.5, while Twitter costs only a little bit more, at 24.2 times sales.

Does that make Weibo cheaper than Twitter? Maybe. A bit. But it still doesn't make the stock a buy. I'm siding with WallachBeth on this one, and against Goldman Sachs.

So how about Qihoo 360? The Chinese search engine got a buy rating of its own today, this time courtesy of French investment banker BNP Paribas. Priced at $82 and change today, Qihoo is worth at least $100 according to Paribas -- and, incidentally, that's the same price target that analysts at Maxim Group lowered Qihoo to today in their recent price-target rollback.

Maxim noted that while it thinks Qihoo is going to surprise us with "faster-than-expected growth" this year, it worries that investors are less willing to pay up for high growth rates today than they have been in the past. Even so, with Qihoo expected to earn $2.32 this year, $3.50 in 2015, and $5 in 2016 (all figures pro forma), Maxim thinks the stock remains a buy.

Whether they're right depends, as Maxim notes, on whether investors remain willing to overpay for growth -- because make no mistake, a decision to buy Qihoo at today's valuation of 105 times earnings (and 112 times free cash flow) is clearly a decision to overpay.

According to S&P Capital IQ, most analysts who follow Qihoo stock expect the company to grow earnings at about 53% annually over the next five years. But paying a triple-digit multiple to earnings that are only growing in the double digits is rarely a good idea for value investors. In fact, even assuming Maxim's numbers are right, they work out to only about a 60% annualized growth rate -- fast and faster than most analysts expect but not fast enough to justify paying more than 100 times earnings for the stock.

Long story short, the stock's not cheap at today's levels -- and it's not worth what the bankers are telling you it will sell for in a year, either.

SINA qua non
Rounding out our list of too-expensive Chinese stocks today is SINA Corporation -- and here we return to Goldman Sachs for some commentary. Like the company that SINA just spun off (Weibo), Goldman likes parent company SINA Corp., and today the banker resumed covering SINA with a buy rating. Why?

Goldman points out that SINA shares are down 43% year to date against only a 2% decline on the Nasdaq as a whole. The analyst suggests that investors are punishing the company, first, due to fears that China may crack down on "operating licenses for Internet publication and audio-visual content transmission," and second, because they worry SINA will squander the cash it got when it spun off Weibo.

While acknowledging these fears, though, Goldman argues they are overblown -- that SINA shares are being discounted too deeply for the regulatory risk to explain, and that the company is more likely to spend its cash buying back shares, than squandering it on ill-considered acquisitions. Hopefully, Goldman's right about that, but even if Goldman is right, it still doesn't make the stock a buy.

Burning cash and priced at 73 times GAAP earnings, SINA shares simply cost too much for the near-25% rate of earnings growth that analysts assign it. Down 43% to date, SINA shares may be. But they're going to have to fall even further (or earnings are going to have to improve much faster) before this stock becomes a bargain. Until one of these things happens, I'd stay away.

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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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