Shares of clothier Urban Outfitters (URBN 1.82%) climbed as much as 6.4% in Wednesday trading before giving up half their gains and closing the day up 3%. Investors who already own the stock should be pleased with the initial surge -- and those who don't yet own it should be happy Urban Outfitters didn't remain as expensive as it did at its high point.
Wednesday morning, analysts at Morgan Stanley upgraded Urban Outfitters shares to "outperform." The banker didn't change its price target, which remained set at $44 a share. That being said, Morgan Stanley noted that Urban Outfitters shares had "pulled back" 23% "since the end of Q3." As a result, even just a move back to the analyst's old price target would now amount to a 34% profit on today's share price.
Morgan Stanley's math appears to be sound, but what about its reasons for recommending Urban Outfitters in the first place?
The analyst explained that there's a "fashion shift" afoot among Urban Outfitters' target market of teens and adults. After polling 2,000 such shoppers, Morgan Stanley concluded that Urban Outfitters has "fashion credibility" to combine with a strong "merchandising strategy" and "inventory best practices." The analyst expects all of this to translate into strong margins "at all three of" Urban Outfitters' brands this year.
Nor is this the only reason to be optimistic about the stock. Priced at about 17 times GAAP earnings, Urban Outfitters generates even stronger cash profits than its net income suggests. Free cash flow for the past 12 months came to $293 million, or nearly 38% better than reported income.
Valued on this basis, Urban Outfitters sells for only about 12.4 times trailing FCF and seems attractively priced for a stock that most analysts agree will grow earnings at 15% annually over the next five years. Investors looking for an opportunity to buy should be pleased that after surging early on, Urban Outfitters stock ended the day by getting a little bit cheaper.
Check out the latest Urban Outfitters earnings call transcript.