This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, it's downgrades on the menu for Chipotle
Unwrap Chipotle's numbers
Weak sales numbers from Chipotle have investors feeling suddenly mild on the stock, and Wall Street is no exception. Underwhelmed by 8% same-store-sales growth (9.4% was expected), analysts at Argus are pulling their buy rating on the stock and downgrading to hold.
The stock's defenders will argue that this is the wrong call -- that 8% is hardly a small number, after all. Plus, earnings growth of 61% exceeded analyst estimates by quite a bit. But when you consider how much optimism is still baked into the stock price, it's hard to fault Argus for turning cautious.
Make no mistake: Priced at 37 times earnings, Chipotle would still be a bargain if anyone believed the company could keep up the pace of 61% annualized growth. Problem is, most folks on the Street know that's just not possible. Over the long term, 22% is a more realistic number, and this is the consensus estimate for what Chipotle will likely produce, on average, over the next five years. Unless Chipotle comes back to us in three months and proves this number too conservative, the stock has further to fall.
Speaking of tumbling stock prices, DeVry is giving us a case study in how fast a stock can fall on bad news. Yesterday, DeVry issued an earnings pre-announcement for Q4 results, warning that the $0.79 per share that Wall Street was expecting is just not going to happen. In the best-case scenario, the company hopes to earn perhaps $0.46 per share.
The news opened a trapdoor under the stock, which promptly plunged 24% in early Tuesday trading. Adding insult to the injury, analysts at Barclays and Morgan Stanley are slashing their target prices (to $21 and $32, respectively). Meanwhile, everyone from Topeka Capital to Oppenheimer to Citi to Bank of America is downgrading the stock (mostly to variations of hold).
Perversely, though, this may be good news for new investors. Consider: If DeVry's new estimate is as bad as it gets, it suggests Wall Street estimates of $3.54 per share are about 10% above the true mark. Accordingly, DeVry should probably earn something like $3.20 or so this year.
Which means the question today really is -- should you be willing to pay the going rate of $21, or about 6.5 times this year's profits, for DeVry? Maybe you should. With a long-term growth rate of nearly 9%, and a modest 1.1% dividend yield to boot, DeVry's valuation doesn't look particularly pricey. And one thing's for sure: After this morning's sell-off, it's already a whole lot cheaper than yesterday.
Dollar General charges ahead
And speaking of good prices, analysts at FBR Capital think they've found a real blue light special on the shelves of Dollar General. Priced at $52 a share today, FBR upped DG's target price to $61 a stub, suggesting a potential 17% profit for investors who follow their advice and buy the stock.
Good advice? Unfortunately, not.
To begin with, at 22 times earnings, Dollar General already looks expensive relative to 18% long-term growth targets. (Remember, as with DeVry, what you're looking for is a P/E ratio that is lower than the stock's long-term growth rate.) Plus, while GAAP profit looks good enough ($823 million earned over the past year), true free cash flow ($451 million) backs up only about 55% of reported income. So this stock that already appears expensive on the surface is actually even pricier when valued on its free cash flow.
Long story short: There's no reason to go long on this stock at today's prices.
Fool contributor Rich Smith holds no position in any company mentioned. The Motley Fool owns shares of Chipotle Mexican Grill. Motley Fool newsletter services have recommended buying shares of Chipotle Mexican Grill.