Wednesday's Top Upgrades (and Downgrades)

Analysts shift stance on Pegasystems, Quality Systems, and PotashCorp.

May 21, 2014 at 11:31AM

This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, we'll look at a pair of "system"-atic upgrades for shares of Pegasystems (NASDAQ:PEGA) and Quality Systems (NASDAQ:QSII), both now rated buy on the Street. But before we get to that good news, let's first take a quick look at why another analyst is...

Putting Potash(Corp) in a hole 
Stock markets are broadly up this morning, but fertilizer giant PotashCorp (NYSE:POT) is sitting out the rally, dropping more than 1% in early trading. For this you can thank Raymond James, which this morning downgraded the stock from outperform to market perform.

Raymond named valuation as its primary concern about the stock. This is curious, given that PotashCorp shares are actually down 12% over the past year -- but it's not necessarily a wrong call (just late).

PotashCorp shares sell for more than 20 times earnings, after all. And while that's a cheaper valuation than the 50 times earnings multiple at archrival Mosaic (NYSE:MOS), it's still not exactly cheap, given that few analysts expect PotashCorp to grow earnings even as much as 7% annually over the next five years. (Mosaic is pegged for slightly greater growth of 8%).

S&P Capital IQ data lists PotashCorp's trailing free cash flow at $1.66 billion for the past 12 months, slightly better than the company's $1.57 billion in generally accepted accounting principles net income. But even so, that's only enough free cash to drop its price-to-free cash flow ratio to 18.7 -- still pricey for a sub-7% grower. With PotashCorp carrying $3.7 billion in net debt, I'd argue the stock's arguably even more expensive than it looks, whether valued on earnings or free cash flow.

Long story short, PotashCorp shares are overvalued, and Raymond James is right to downgrade them. The real question is, what took so long?

Will Pegasystems fly?
Turning from bad news on fertilizer stocks to good news on tech, we begin with business process management software provider Pegasystems, which Wedbush this morning upgraded to outperform. Wedbush sees Pegasystems hitting $27 within a year -- a 33% profit for buyers today of a stock at $20 and change.

Quoted on this morning, Wedbush stated: "PEGA's 2-year-old initiative to cultivate partnerships with large system integrators and grow its partner ecosystem is yielding positive results, helping PEGA to expand its market footprint, accelerate sales activity, shorten sales cycles, and close larger deals." The analyst sees revenue growing, and growing more predictably, lending more confidence to investors interested in buying the stock. But is Wedbush right?

At first glance, you'd have to be a real optimist to have confidence about this stock's potential to earn you a profit. Pegasystems shares sell for more than 41 times earnings, after all, a price that appears high even assuming the company can hit the 25% earnings growth rate that Wall Street projects. But looking a little closer, Pegasystems shares may not be quite as pricey as they seem.

S&P Capital IQ data shows that Pegasystems generated nearly $82 million in positive free cash flow over the past year -- more than twice the company's reported net income. Valued on this free cash flow, rather than on its GAAP income, the stock appears to trade for less than a 19 times multiple to cash profit. That's a very reasonable price to pay for 25% growth, if Pegasystems can deliver. Last quarter, earnings grew only 8%. But if the analysis is right, and brighter earnings days lie ahead, then this stock could well deserve the outperform rating just bestowed by Wedbush.

Another Quality investment?
The situation with electronic medical records company Quality Systems is similar to what we find at Pegasystems, but more so.

Priced at a seemingly sky-high valuation of 158 times earnings, Quality Systems churns out so much more cash profit than it is allowed to claim as "earnings" under GAAP -- $83.5 million in free cash flow over the past 12 months alone -- as to give the stock a much more reasonable-sounding price-to-free cash flow ratio of just 11.5. The company sports a debt-free balance sheet and, awash in cash itself, is not reluctant to share it with its shareholders. The annual dividend yield is a generous 4.6%.

Truly, the only "issue" with this stock seems to be its growth rate, which according to Yahoo! Finance numbers is set to just crawl along at 1% annually over the next five years -- in a software industry expected to grow north of 18%.

How likely is it that Quality Systems will underperform its peers by so much? RBC Capital seems to think it's not very likely at all, and this morning released a note rating Quality Systems at outperform, predicting that the shares will climb by roughly 19% over the next 12 months. I agree with that assessment. Judging by valuation alone, Quality Systems looks to be the cheapest stock on today's list -- and the best opportunity to consider buying.


Rich Smith has no position in any stocks mentioned, and doesn't always agree with all the stocks his fellow Fools like. Case(s) in point: The Motley Fool recommends Pegasystems and Quality Systems, but The Motley Fool also owns shares of PotashCorp.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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