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...
Well, gee. That was fast.
Last week, investors punished "security-as-a-service" provider Proofpoint (NASDAQ:PFPT) after the company reported Q3 earnings that beat analyst estimates on both the top and bottom lines. Proofpoint stock sold off by nearly 17% before the trading day was done.
And yet, in the midst of the sell-off, I noted: "Proofpoint actually beat" estimates for last quarter, and it issued new guidance suggesting it was poised to beat earnings again in Q4. I predicted: "Don't be surprised, therefore, if today's sell-off turns around in a hurry and Proofpoint resumes its rise once the upgrades begin rolling in."
Well, I'll give you three guesses what happened this morning.
Proofpoint wins upgrades -- and its stock turns around
That's right. Proofpoint stock is making a U-turn as trading gets underway Monday, up nearly 7% as of 11 a.m. EDT. And the reason for the turnaround, I suspect, is the fact that this morning, two of Wall Street's best and brightest upgraded Proofpoint stock in response to its earnings and guidance.
The first is Goldman Sachs. According to StreetInsider.com (subscription required), the analyst characterizes last week's sell-off as a mere "reset" of investors' "expectations" for the stock -- one that should permit the stock to resume rising as it meets and exceeds expectations going forward. Goldman notes that it considers Proofpoint "a market leader in email security," capable of growing revenue "at 20% CAGR for 2018-2021 period." One can presume that earnings would grow even faster than that if margins expand -- and indeed, on S&P Global Market Intelligence, analysts are quoted predicting long-term earnings growth of 28% annually over the next five years.
Goldman Sachs values Proofpoint stock at $114 a share (about 28% above current prices) and rates the stock a buy.
Second verse, same as the first
Proofpoint's other fan this morning is investment banker KeyBanc, which advises investors to overweight Proofpoint stock today, and believes it's worth even more than Goldman's estimate -- $120 a share. "[S]ignificant market tailwinds" favor Proofpoint, argues KeyBanc, and like Goldman, the analyst believes that "the reset of expectations" is providing investors an attractive entry price on the stock.
Caveats and provisos
And yet, not everyone's 100% enthusiastic about Proofpoint. At the same time as Goldman and KeyBanc were upgrading Proofpoint stock today, Morgan Stanley was cutting its price target on Proofpoint (but maintaining an overweight rating on the stock regardless).
Two other analysts cut their price targets on the stock last week -- albeit to $115 and $120, or right about at the same level where Goldman and KeyBanc think the stock is a buy. JMP Securities ($115) called Proofpoint's guidance "significantly below consensus," according to TheFly.com. Wells Fargo ($120) lamented "execution missteps in Proofpoint's global expansion strategy." Nonetheless, these analysts also retained outperform ratings on the stock.
The upshot for investors
So how should investors react to this flurry of price target cuts, combined with buy ratings either maintained or newly instituted? Here's how I look at it:
Prior to earnings last week, Proofpoint stock was overvalued and generating too little free cash flow to justify its $5.6 billion then-market cap. But with stronger free cash flow, and an improved valuation of just $4.55 billion after Friday's sell-off, Proofpoint is starting to look more attractive.
Proofpoint predicts it will generate more than $150 million in free cash flow this year -- right in line with analyst estimates. This free cash flow should grow 33% next year to $200 million, then grow 32% more in 2020 before settling down into low- to mid-20s growth rates, according to S&P Global estimates. If these estimates are to be believed, Proofpoint will produce 28% annualized long-term earnings growth over the next five years.
At a valuation of 30 times free cash flow, with no debt on its balance sheet and just under $200 million in cash, I believe Proofpoint is very close to fairly priced after last week's sell-off -- if it can maintain the growth pace that Wall Street expects it to. Given that Proofpoint has already generated 39% FCF growth through the first nine months of 2018...I'd say the company is already off to a running start.