At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.
Guns versus money
Perhaps still addled by the electrical charges in the atmosphere post-Sandy, Wall Street's making some pretty curious stock picks this morning. On the one hand, analysts at CL King have decided to downgrade shares of two gun companies -- Sturm, Ruger (NYSE:RGR) and Smith & Wesson (NASDAQ:AOBC). Meanwhile, analysts crunching the numbers at a couple of the biggest names in credit cards are taking different tacks on MasterCard (NYSE:MA) and Visa (NYSE:V).
Do these ratings make sense? Let's find out.
Analyst exits the bar, guns blazing
Starting at the top, we find analyst CL King taking a powder on both of the leading publicly traded gun manufacturers today, Smith & Wesson and Sturm, Ruger. Presumably, it's pocketing a profit, too. Over the past year, shares of Sturm are up a respectable 45%, while S&W has totally hit it out of the park -- up 220% and counting.
A bird in a hand -- or 220 of 'em -- being worth a whole lot more than however many may be left in the bush, it's hard to fault King for thinking now might be a good time to head for the exits. The potential for gains on fears that "Obama will take away your guns" have pretty much run the course (unless of course these fears get a new boost next week). And with their shares trading for 16 times (Ruger) and 18.6 times earnings (S&W) it's arguable the stocks have run their course...
On the one hand, Ruger at 16 times earnings looks a bit overpriced for an industry that most analysts think will average only about 12% earnings growth over the next five years. The company pays a nice dividend -- 3.3% -- which helps the valuation a bit. But Sturm generates significantly less free cash flow than what it reports as net income under GAAP, suggesting a low quality of earnings and little potential for future growth in the share price.
At Smith & Wesson, in contrast, all the stars seem to align in favor of a positive outlook. The company's sub-19 P/E ratio looks attractive in light of analyst expectations for 22% long-term-earnings growth. Free cash flow is strong -- about 40% higher than the company's reported net income. And the company has more cash in the bank than debt on its books -- a near-pristine balance sheet.
Long story short, I'd be long Smith & Wesson, but short Sturm, Ruger.
And speaking of cash...
Meanwhile, as Wall Street comes down hard on guns today, it's sending us some mixed signals on money. More specifically, electronic money. Credit cards.
Yesterday, MasterCard underwhelmed Wall Street with below-consensus revenue numbers, but still managed to beat on earnings ($6.17 per share). Visa, in contrast, beat on both earnings ($1.54) and revenues ($2.73 billion). This performance won Visa a pair of improved price targets this morning, as Stifel Nicolaus upped its prediction to $156 per share, while Barclays came in just a hair lower at a $155 one-year-price target. Meanwhile, Stifel sliced a few bucks off its guidance for MasterCard, now expected to sell for $527 a share next year.
These conclusions may surprise investors who focus too closely on P/E ratios, given that Visa currently costs 70 times its trailing GAAP earnings, while MasterCard looks like a relative bargain at 28 times. But there is at least some method to Wall Street's madness here.
You see, while both companies generate more cash profit than their income statements suggest, MasterCard's $2.8 billion in free cash flow is only enough to drop its P/FCF ratio down to about 21 -- at best fairly priced, and at worst a bit overvalued, for a 19% grower. In contrast, the gulf between Visa's reported income and its actual free cash flow is just staggering. The company reported earning only $2.1 billion over the past 12 months, while actual cash profit at the company came to more than $4.6 billion.
Granted, I don't think that's enough to justify Visa's premium valuation, which works out to a P/FCF ratio of nearly 46. To my Foolish eye, that's still way too much to pay for a company that most analysts think will achieve only about 21% annual profits growth over the next five years. But it does explain why some analysts might prefer Visa over its rival.
For me, though, as a value investor I guess I just prefer guns over money -- and Smith & Wesson over Sturm, Ruger. Whose advice should you take -- mine, or that of "professional" analysts like CL King, Barclays, and Stifel Nicolaus? Check out my track record on Motley Fool CAPS, and compare it to theirs. Decide for yourself whom to believe.
Fool contributor Rich Smith does not own (or short) shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 300 out of more than 180,000 members.
The Motley Fool owns shares of MasterCard. Motley Fool newsletter services recommend Visa. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.