This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense and which ones investors should act on. This morning, we look at three bullish calls making the rounds on Wall Street: A new buy rating for Under Armour (NYSE: UA), an upgrade for ARM Holdings (Nasdaq: ARMH), and a huge hike in price target at Blue Nile (Nasdaq: NILE).
Under Armour could go back over $100
First up: Under Armour, recipient of a double upgrade on Wall Street courtesy of both The Benchmark Co. and UBS. UA slipped from its $101 peak price during the recent market pullback, but according to the analysts at both UBS and Benchmark, this bad news is really good -- because it gives investors a second bite at the apple. An opportunity to own a "brand we love."
As quoted in StreetInsider.com today, Benchmark waxes poetic about UA's "multiple growth opportunities," its culture of "innovation (i.e. Charged Cotton, Cold Black)," and its expansion into footwear, women's sports clothing, direct-to-consumer sales, and international markets. With the stock down four times as much as the rest of the S&P 500 since May's pullback began, Benchmark believes now's a great time to "own a name where we expect at least 20-25% top-line growth."
There's just one problem with that thesis: Even after the pullback, Under Armour shares now cost 50 times earnings. Even taking Benchmark's most optimistic forecast as a given, this works out to a 2.0 PEG ratio -- about twice what most value investors will tell you is a fair price to pay for a stock.
It costs an ARM and a leg
And speaking of pricey stocks, ARM Holdings. Like UA, ARM is a fast grower -- 18% annual earnings growth for the next five years, if analyst estimates are to be believed. Less debatable is the high price tag -- 52 times the company's $0.45 per share in trailing earnings.
While acknowledging the high price tag, though, and declining to rate the stock an actual buy, analysts at D.A. Davidson this morning did finally remove their "underperform" rating on ARM and upgrade to "hold." Davidson explains its move thusly: "Recent news of Samsung ramping up research and development around an ARM-based server system chipset leaves us optimistic about the company's opportunity in the market." Add to this Davidson's belief that "at least two large name semiconductor players announcing ARM-based server solutions before the end of the calendar year ... with others to follow," and it starts to feel dangerous shorting the stock.
But here's the thing: Even if Davidson is right about the positive news flow at ARM, growth forecasts for this company are already highly optimistic -- and the price already reflects this. For ARM to deserve its 50-plus P/E ratio, we'd really like to see growth rates above the teens -- even the high teens. Maybe ARM will produce this growth, but if it fails to, look out below. At these price levels, Mr. Market isn't pricing in any risk of failure.
Low tide at Blue Nile
And speaking of failures, did you get a chance to look at Blue Nile's first-quarter earnings report yesterday? The company met expectations for earnings but missed on revenue -- and the stock's up 11% in response! Why? Probably because Blue Nile promised to do better in the second half of this year, earning as much as $0.85 per share in full-year profits.
Not everyone's impressed. Hedging its bets against the optimistic guidance, Benchmark (yep, the same folks who just upped their rating on Under Armour) raised its price target on the stock to $32. But even Benchmark can't quite bring itself to endorse buying the stock, which it still rates a "hold." As the analyst explains, for Blue Nile to hit its new targets, it will need to produce "significant acceleration in operating leverage." But management has a lot of work to do to achieve those revenue goals.
The situation's actually even worse than that, though. Even if Blue Nile hits its mark, $0.85 per share would still have the stock selling for a 36 P/E. That's a pretty steep price for a company that most analysts think can only maintain 15% annual growth over a long period of time. In this instance, Benchmark is playing it safe -- and it's right to do so.
Fool contributor Rich Smith holds no position in any company mentioned, but The Motley Fool owns shares of Under Armour. Motley Fool newsletter services have recommended buying shares of Under Armour and Blue Nile. Motley Fool newsletter services have recommended creating a position in Blue Nile.
