Thursday's Top Upgrades (and Downgrades)

Analysts shift stance on Bankrate, Microsoft, and Zillow.

Jun 5, 2014 at 11:08AM

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 turns its focus to tech stocks, with new buy ratings for Microsoft (NASDAQ:MSFT) and Bankrate (NYSE:RATE), but a downgrade on Zillow (NASDAQ:ZG). Let's get the bad news out of the way first...

Zeroing in on Zillow
As most markets wobble around the zero-change mark, shares of online real-estate information provider Zillow are taking a dive this morning, down more than 1% on a negative report out of SunTrust Robinson Humphrey. But is the news really bad enough to justify the price decline?

Quoted on today, SunTrust informs: "We are lowering our rating today on Zillow to Neutral from Buy, based on the strong run the stock has had and its sustained surpassing of our $110 year end 2014 target." That being said, the analyst says it is still "very bullish on the long term prospects for the company." SunTrust simply thinks that whether you value the stock on "EV / Revenue / growth, EV / EBITDA / growth, [or] EV / EBITDA / rev growth," Zillow shares look a bit pricey. Now that doesn't sound so scary, does it?

Actually, yes, it does. Because "EV / Revenue, etc." doesn't begin to describe the true scope of the overvaluation at Zillow.

Unprofitable over the past year -- and unprofitable in three of the past five years as well -- Zillow shares currently trade for a P/E ratio of infinity. Valued on cash profits (free cash flow), the stock looks nearly as expensive at a price-to-FCF ratio of 240. So even assuming that analysts' phenomenal expectations of near-65% annualized profits growth (according to Yahoo! Finance figures) are accurate, the stock still looks expensive.

Indeed, some of SunTrust's own statements in its note on Zillow suggest the shares could be as much as 50% overvalued. The analyst notes that for the three metrics it lists above, most tech stocks sell for price multiples of "0.2x, 0.5x and 0.9x." But "for an investor to receive a 15% return from yesterday's close," Zillow shares would need to sell for "higher multiples of 0.3x, 0.7x, and 1.4x" -- half again as much as Zillow's peers cost. If that's not reason enough to downgrade the stock, I don't know what is.

Microsoft can't miss?
Moving on now to happier news, shareholders of Microsoft are enjoying a modest rise in stock price today in response to an upgrade to outperform from FBR Capital. FBR has kind words for new CEO Satya Nadella, and thinks he's guiding the software maker well toward "the transition to mobile." The analyst also expresses hope that Nadella will steer away from the expensive, ill-considered acquisitions of his predecessors, and finally begin to enjoy a "long-awaited growth in free cash flow ... representing a breath of fresh air for investors." But is that reason enough to buy the stock?

Sad to say, no it is not. Here's why: According to S&P Capital IQ figures, Microsoft generated $22.7 billion in positive free cash flow over the past 12 months. That sounds like a lot of money, but was in fact a decline from the $29.3 billion in FCF pumped out in 2012. Even if Nadella is able to turn this decline around, though, it still leaves the stock selling for more than 15 times earnings and nearly 15 times free cash flow.

Working off the 7% long-term growth in profits that most analysts foresee for Microsoft, or the more modest 5% growth that FBR envisions in 2015, and either way, you're still looking at a stock selling for a double-digit P/E, but showing only single-digit growth. That's not usually a winning proposition in stock investing -- and it's not a good reason to recommend Microsoft.

Can you bank on this upgrade?
I'm similarly pessimistic about our other tech upgrade of the day -- Bankrate -- albeit with a glimmer of hope. Citing a 30% decline in share price "from recent highs," but an improving outlook for the insurance and credit card markets, RBC Capital announced today that it's reentering shares of Bankrate with an upgrade to outperform.

The idea is not entirely without merit.

While unprofitable under GAAP accounting rules, Bankrate is actually a pretty prolific generator of free cash flow, producing nearly $89 million worth of cash profits over the past year. This works out to about an 18x multiple to FCF on the stock -- much more attractive than its current P/E ratio, which like Zillow's, is "infinity" due to the stock's lack of GAAP profits.

Most analysts expect that Bankrate will only grow earnings at about 12% to 13% annually over the next five years, however, which is probably too slow to justify the 18x FCF multiple on the stock. Bankrate's industry as a whole, however, is expected to grow profits at north of 16%. If you consider Bankrate a superior company to the average, as I do, then it seems at least possible that the company will match, or exceed, industrywide earnings growth. If that's the way things play out, then the stock may not be quite as overpriced as it now appears.

That being said, I'd still like to see a bit more of a margin of safety in this one. Bankrate may one day be the buy that RBC says it is, but until we start seeing more profits growth, I'm going to sit on the sidelines and consider this one a hold, myself.


Rich Smith has no position in any stocks mentioned, and doesn't always agree with his fellow Fools. Case(s) in point: The Motley Fool recommends Zillow, and The Motley Fool owns shares of both Microsoft and Zillow. 

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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