Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Finding bargain stocks in an overvalued market is no easy task, but finding relative bargains? Stocks that, if not necessarily cheap, may at least be cheaper than the average stock on the S&P 500, where price-to-earnings ratios continue to float north of 26? That may be a bit easier to do.
In fact, Raymond James thinks it has done it -- and that's why the investment banker upgraded shares of financial data and analytics specialist S&P Global (SPGI 2.37%) this morning. Here are three things you need to know about the upgrade.
1. Like a phoenix from the ashes reborn
Long regarded as one of the "villains" of the 2008 financial crisis, in which its debt-rating arm was accused of handing out too-high ratings for banks' issuances of mortgage-backed securities, S&P Global began pulling itself out of the ashes last year. In 2014, the company incurred $1.6 billion in legal and other costs relating to the crisis, pushing its bottom line into the red. Then, in 2015, the movie The Big Short came out, reminding investors how S&P Global got itself into trouble in the first place.
But S&P pulled through like a champ, first honing its business model with the $2.2 billion purchase of SNL Financial in 2015, then exiting its non-core educational textbooks business in 2016, and finally changing its name (the company had previously been known as McGraw-Hill).
Result: One year after its loss, S&P Global reported $1.2 billion in fiscal 2015 profits, then nearly doubled those profits to $2.1 billion in 2016.
2. Raymond likes S&P Global
Raymond James thinks the good news won't stop there. As reported this morning on StreetInsider.com, Raymond James has decided to upgrade S&P Global stock from market perform to outperform, and is assigning a new price target of $143, implying about 12% upside to the shares.
Why? Raymond James sees S&P Global growing its revenue at a consistent, double-digit growth rate over the next several years. The analyst also believes that S&P will be able to expand the profit margin it earns on that revenue. (Indeed, since the dark days of 2014, S&P Global has already added 150 basis points to its gross margin, and grown its operating profit margin by 460 basis points, according to data provided by S&P Global Market Intelligence itself.)
With a 68.8% gross profit margin and a 40.4% operating profit margin, S&P Global now easily outclasses archrival Thomson Reuters' (TRI 2.00%) numbers (28.2% and 13.8%, respectively).
3. Valuing the options
But are those numbers good enough to justify buying S&P Global over Thomson Reuters stock -- or any other stock, for that matter?
Let's consider: Valued at $33.6 billion and $31.4 billion respectively, S&P Global and Thomson Reuters are roughly the same size by market capitalization. This is despite the fact that Thomson Reuters rakes in much more revenue ($11.2 billion annually) than S&P ($5.7 billion), and largely because S&P Global earns much better profits off the revenue it does collect. This also explains why investors value S&P Global stock so much more richly as a multiple of its profits -- 15.7 times earnings as opposed to Thomson Reuters' P/E of 10.
That said, when you consider these valuations in light of the stocks' respective growth rates, I cannot help but think that Raymond James has missed the point: Thomson Reuters stock actually looks to me to be more of a bargain than S&P Global.
The most important thing: Considering your alternatives
Here's why: Compare S&P Global's 15.7 P/E ratio to analysts' projection of 13.5% long-term annual earnings growth and the stock's 1.3% dividend yield. Those two latter numbers add up to a total return of 14.8% on S&P Global stock, and when divided into the P/E, a total return ratio of about 1.1. While I agree with Raymond James that this is a "reasonable" valuation, as TheFly.com reports, it's not yet cheap.
For cheap, look instead to Thomson Reuters. There, 10 times earnings matches up nicely with analysts' projected 10% long-term growth rate. Factor a 3.2% dividend yield into the mix, and Thomson Reuters stock generates a total return ratio of less than 0.8 -- which most definitely is cheap.
Long story short: I agree with the analyst that S&P Global stock sells for a reasonable price and presents a decent value at today's prices. But Thomson Reuters is the cheaper stock for long-term profits.