Every day of the workweek, Wall Street's diligent worker bees dole out dozens of upgrades, downgrades, new ratings, and price tweaks on the ratings they've already issued. "Buy" this, "sell" that, "aggressively accumulate" the other. The instructions come fast and furious, and judging from the shifts in stock price that follow each, a lot of investors closely follow what the Street's best and brightest have to say about their stocks.
But should they?
This new series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on.
We begin with three high-profile ratings moves making the rounds on Wall Street this morning: a new buy rating for Westport Innovations
Westport heads north
All indications suggest this is going to be a "green" day for Westport Innovations shareholders. The company that specializes in converting diesel engines to run on natural gas received its third buy rating in two weeks this morning, as Wall Street stalwart Piper Jaffray joined previous Westport backers Macquarie and Capstone Investments in endorsing the stock.
According to Piper, this $37 stock is likely to tack on upward of $10 to its share price over the next 12 months, hitting $47.50 per share before a year is out.
Is Piper right? Your guess is as good as theirs. With Westport currently unprofitable, and expected to make no profit this year (or even next year), there really isn't a lot to hang a valuation on for this stock. From a traditional PEG ratio perspective, analysts' consensus earnings growth target of 30% for the next five years would ordinarily mean we'd want to see a P/E of 30 or less on the stock. This, however, would require Westport to be pulling in about $1.24 per share in profit. Last year, Westport lost $1.28.
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Yesterday's news that AOL has managed to squeeze $1 billion out of Microsoft
It's also sparked speculation about what else AOL has up its sleeve. This morning, Needham rushed out and upped its price target on AOL to $31 in anticipation of further news, suggesting that even after yesterday's 43% bump, there's still another 20% or so worth of profit to be had from AOL.
They could be right about that, too. While technically "unprofitable," as GAAP calculates such things, AOL actually generated some $214 million in free cash flow last year. At a valuation of less than 12 times annual cash production, the stock looks plenty cheap already. But once you factor in the $1 billion AOL will soon receive from Microsoft, the stock's enterprise value to free cash flow drops even further -- to just 5.6!
Think AOL can manage to produce enough profits growth to justify that lowly multiple? Needham's upping its expectations seems to suggest the answer is yes.
Chesapeake loses energy
Finally, and with apologies for ending on a down note, we turn to today's headline-making downgrade: Chesapeake Energy. In the face of a reiterated "buy" rating from Canaccord Genuity, and an upgrade from Capital One, analysts at Tudor Pickering broke from the pack this morning to cancel their buy rating on Chesapeake and downgrade to "accumulate." But what does that really mean?
You can hardly "accumulate" shares without buying them, right? (That is, unless Grandma is in the habit of tucking stock certificates inside your birthday card.) So even as Tudor's recommendation seems to be a downgrade, the analyst's still suggesting there's value to be had in the shares.
Don't be so sure. Consider: At 9.5 times earnings, Chesapeake may look undervalued relative to consensus expectations for 13.6% long-term earnings growth. But what kind of "earnings" are we talking about, really? Last year, even as it reported a $1.7 billion "profit," Chesapeake actually burned through $8.5 billion in negative free cash flow. Indeed, Chessie's burned cash for five straight years, and the last time it actually generated positive free cash flow (2006), the sum was hardly inspiring: a paltry $77 million.
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Motley Fool contributor Rich Smith does not own shares of, nor is he short, any company mentioned above.
The Motley Fool owns shares of Microsoft. Motley Fool newsletter services have recommended buying shares of Chesapeake Energy, Westport Innovations, and Microsoft. Motley Fool newsletter services have recommended creating a bull call spread position in Microsoft. The Motley Fool has a disclosure policy.
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