This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, our trio of top headlines includes a buy rating for Western Digital
Go West(ern), young investor!
First up, Standpoint Research is ready for another go-round with hard-disk-drive maker Western Digital, a stock it endorsed back in July, then downgraded last month when it "got ahead of itself" and came too close to the analyst's price target. That turned out to be a fortuitous exit, as Western D soon after announced lower revenue guidance, and lost 12% of its market cap in response.
Now, according to StreetInsider.com, Standpoint advises investors to take advantage of the market's overreaction to Western D's bad news. Argues the analyst: "Even if WDC delivers $8.00 and not the $10.00 in EPS they are forecasting the shares are still undervalued by 20%. In a worst case scenario I see WDC earning $8.00 in 2014."
Assuming Standpoint's right about those earnings, it's right to recommend the stock as well. Western Digital already sells for a very low P/E ratio of just 6. Give it $8 in earnings per share this year, though, and that P/E ratio drops to just 5. Fact is, Western Digital does not need to earn $10 (and get, by the way, a P/E ratio of 4) to become buyable. 4, 5, 6 -- these are all really low multiples to earnings, folks. At these prices, Western Digital almost looks cheap enough to buy no matter what it does earnings-wise.
Panera gets stale
Now contrast that with Panera Bread, which, after posting sizable gains over the past year, now costs a whopping 33 times earnings. Prices like these require that Panera grow smartly to justify the multiple investors are paying for earnings. Unfortunately, even the 19% long-term growth rate most analysts expect to see at Panera probably isn't up to the task.
This morning, analyst Miller Tabak took a good hard look at Panera's price and prospects... and decided to declare victory and go home. The past 12 months, after all, have yielded 50% gains for Panera shareholders already. Expecting Panera to generate even more profit for its shareholders after such an incredible run-up seems ungrateful -- and almost greedy.
Sure, Panera remains a superb business, generating superior free cash flow and generating a debt-free, cash-rich balance sheet. It's not a stock you should feel compelled to sell today. But Miller Tabak is right -- it's no longer cheap enough to justify a "buy."
Bed Bath and Buh-Bye
Similarly, Oppenheimer's decision to downgrade Bed Bath & Beyond today looks like investors' cue to head for the exits. Bed Bath shares have barely kept pace with the rest of the market over the past year. Oppenheimer warns that they're only like to "perform" as well as the broader market over the coming year as well -- and it's hard to argue with that assessment.
Priced at 16 times earnings, but slated for only 11% long-term earnings growth, Bed Bath shares are anything but cheap. To the contrary, its P/E ratio sits a full point above the average P/E for companies in the retail industry, while its growth rate is a full 2.5 percentage points slower than the average. While probably the premier name in middle-class home furnishings retail today, the stock's been richly rewarded for its performance already, and has little room left to run.
Oppenheimer's right to downgrade it, and investors should avoid it.
Fool contributor Rich Smith holds no position in any company mentioned. The Motley Fool owns shares of Western Digital and Panera Bread. Motley Fool newsletter services have recommended buying shares of Panera Bread and Bed Bath & Beyond.