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're checking in as Dean Foods (DF +0.00%) scores an upgrade, Tyco (TYC +0.00%) gets downgraded, and for Children's Place (PLCE 1.70%), it's a shift in price target. Let's dive right in.
Dean of the school
Milk maker Dean Foods is behaving like anything but milquetoast this morning, outshining a weak stock market with a 2% rise. For this, you can thank the friendly analysts at Stifel Nicolaus, who just upgraded the stock to "buy." With analysts predicting strong profits growth at the company -- 19% per year over the next five years -- it's not hard to see why Stifel might like the stock. But should you?
Perhaps not. For one thing, unprofitable Dean currently has no trailing profits to grow. So it's not entirely clear what the "19% growth rate" really refers to. Maybe it's free cash flow, which the company does have a bit of ($206 million over the past 12 months). That might be good enough, considering the growth rate, if it weren't for one thing: Dean's debt.
Dean carries $3.6 billion in net debt, you see, a number even bigger than its own market cap. And when you factor this debt load into the valuation, the stock's trading for about 30 times trailing free cash flow. That's probably too high a valuation for even a 19% growth rate to justify. Chances are, Stifel's buy recommendation will go sour before anyone sees much of a profit on this stock.
Tyco's still king
In contrast, Tyco International boasts a similar growth rate of nearly 19%, but much more profits to build on. The company's sub-10 P/E ratio and superior free cash flow ($1.7 billion, versus reported earnings of only $1.3 billion) give the stock a very attractive valuation. A valuation that only looks better in light of the stock's 2.1% dividend payout.
All of which makes it all the more surprising that after looking closely at the stock this morning, analysts at Credit Suisse decided to downgrade Tyco stock. Credit Suisse cut Tyco's rating to "neutral" today, but even CS admits the stock's worth more than it's currently selling for -- $30. Me, I look at these numbers and think Tyco could be worth quite a bit more than that.
My advice: This is one downgrade you should immediately disregard. Tyco was a bargain before CS knocked it. It's an even better bargain after the post-downgrade sell-off.
Put your money in The Children's Place?
And now, with apologies for ending on a down note, we turn to our third and final ratings change of the column: Children's Place, which just scored a modest bump in target price from the analysts at FBR Capital.
Children's Place has already shot past FBR's target price of $55, which puts the analyst in something of a pickle. FBR doesn't recommend buying the stock, but by the same token, it couldn't very well continue to counsel holding shares that, by its own estimation, were already more than 11% overvalued. Faced with a choice between downgrading to sell and upping its price target to follow an irrational stock market higher, FBR chose the latter.
It was wrong to do so.
Priced at more than 21 times earnings, but expected to grow these earnings at no more than a high-single-digit rate over the next five years, Children's Place is pretty clearly overpriced. The logical thing to do when Mr. Market takes an overpriced stock and bids it higher is, of course, to short the stock. That's what FBR should have done. Instead, it raised its target price, and basically gave investors its permission to keep holding on to a stock that already costs more than it's worth. It's a decision FBR may one day regret... but no more so than the investors who follow its advice, and end up losing money as a result.
Fool contributor Rich Smith has no positions in the stocks mentioned above. The Motley Fool owns shares of Dean Foods.
