This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, we'll look at why one analyst is panning shares of McDonald's
Bad news first
Shares of McDonald's are off to a weak start Friday morning, dropping 3% in response to a downgrade (to neutral) from Janney Capital Markets. Warning that this month is shaping up to be McDonald's worst month year to date for same-store sales growth, Janney said the bad news won't end with September.
"The Street in general may be overestimating the U.S. same-store sales that McDonald's may be able to generate over the next 6-9 months," warns the analyst. And considering that the shares have gained a healthy 8% over just the past few weeks' trading, Janney thinks now might be a good time to exit, stage left -- take the easy profits, and avoid the tough times ahead.
It's hard to argue with that logic. Priced at 17 times earnings, suffering from weak free cash flow and a sizable debt load, McDonald's shares already look significantly overvalued today. If Janney's right and growth is about to stumble, investors may be well advised to take their winnings off the table and invest them in something with a bit more potential.
If you ask the analysts at Canaccord Genuity, Nike might be one place you could move your McDonald's winnings to. The sportswear company is taking a beating on Wall Street today, leading the market down 2% in response to concerns over weak demand and excessive merchandise discounting in China.
On the other hand, while the $1.23 per share that Nike reported for third-quarter profit was down 10% year over year, it still exceeded most analysts' estimates by a full dime. Sales, up 10%, also exceeded expectations. While Canaccord isn't enthusiastic enough to actually upgrade the stock, it did raise its price target to $94 a share -- about where Nike is trading today. But does Nike deserve even this halfhearted vote of approval?
Probably not. At 20 times earnings, the price looked awfully rich for a company that analysts thought could only manage 8% long-term earnings growth before the earnings warning. Now that growth is sagging, the stock looks even more woefully overpriced.
How about Urban Outfitters, then?
A second analyst making positive noises about a consumer goods stock today is FBR Capital, which just upped its price target on Urban Outfitters to $42. Urban, you see, recently hit the analyst's $37 price target, putting FBR in a bit of a dilemma: It's hard to keep recommending "buying" a stock that already costs what you're on record saying it's worth, so... do you tell your clients to sell the now-fully-priced stock, or raise the price target even higher?
FBR, clearly, opted for Door No. 2. But investors should seriously consider showing Urban the door instead.
Why? Because Urban Outfitters already costs 30 times the amount of profit it earns in a year -- a number that's probably inflated, given that despite claiming $185 million in GAAP earnings over the past year, Urban actually produced less than $75 million in cash profits. The GAAP number shows Urban to be overvalued for its projected 17% long-term growth rate. The company's much lower free cash flow number shows it to be overvalued... on pretty much any growth theory you can imagine.
Fool contributor Rich Smith holds no position in any company mentioned. The Motley Fool owns shares of McDonald's. Motley Fool newsletter services have recommended buying shares of Nike and McDonald's. Motley Fool newsletter services have recommended creating a diagonal call position in Nike.