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Monday's Top Upgrades (and Downgrades)

By Rich Smith - Nov 19, 2012 at 11:58AM

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Analysts shift stance on Diamond Foods, Starwood Hotels, and PetSmart.

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 headlines include a new buy rating for Starwood Hotels (NYSE: HOT) and an upgrade for PetSmart (NASDAQ: PETM). On the other hand, one analyst thinks the case against Diamond Foods ( DMND.DL ) is crystal clear.

Diamond Foods: An easy nut to crack?
Let's get that bad news out of the way first. This morning, reports that Jefferies & Co. has downgraded nut purveyor Diamond Foods to "underperform," cutting its price target by almost two thirds in the process. Decrying the "lack of earnings visibility" and "neg. EPS expectations" at Diamond, Jefferies sees this $15 stock falling to $10 within a year. "While mgmt. seems to have a viable strategy," noted the analyst, "we believe that it will take some time to show positive results and until then we prefer not to own the stock."

No wonder. According to Jefferies, Diamond's no longer expected to earn $0.65 per share this quarter, as it once was. Instead, the analyst tells investors to look for earnings as low as just $0.02 per share. Next year could be even worse. The analyst is expecting a $0.71-per-share loss.

That's rough news for any investors who've been looking past Diamond's currently negative P/E ratio and hoping that the stock might perk up when profits return next year. The forward P/E ratio on the stock, which assumes such an earnings revival, is a pretty pricey 18 already. Remove the chance of 2013 profits, and that P/E zooms all the way up to "infinity and beyond." Investors who'd rather avoid that fate should probably take Jefferies' advice and sell today.

How HOT is Starwood?
It's not all doom and gloom at Jefferies, though. At the same time as it was panning Diamond Foods, this analyst also initiated coverage of a stock it likes this morning: Starwood Hotels.

Calling the hotel manager "an asset-lite operator," and praising the company for scoring "top on our qualitative Jefferies Scorecard," Jefferies likes Starwood's move "toward faster-growing Emerging Markets." The analyst also notes that Starwood sells for an 8% discount to Marriott ( MAR -0.11% ) when valued on "EV/EBITDA."

Sound good so far? It gets better. Under the more traditional price-to-earnings metric, Starwood's 17.7 P/E ratio costs a whopping 20% less than Mariott's 22.1. Starwood also boasts a higher dividend yield (2.4%) and a cleaner balance sheet, with less debt relative to market cap than Marriott carries.

Long story short, Marriott may be growing faster, but Starwood looks like the better bargain.

And speaking of bargains ...
Jefferies wasn't the only analyst trying to pick winners this morning. Over at Barclays Capital, we got a bona fide upgrade for PetSmart (NASDAQ: PETM) today, as the British banker boosted its rating on the pet supplies retailer to "overweight." The prediction here is only for about a 10% gain in the stock, now pegged to hit $75 a year from now -- but the prediction does look promising.

PetSmart shares cost 21.5 times earnings today, which is probably a fair price to pay for the 18%-plus growth that most Wall Street analysts are calling for. But here's the kicker: Historically, PetSmart has produced free cash flow superior to what it reports as net earnings (the "P" in your P/E ratio).

Last year, for example, free cash flow at the company outpaced reported net income by 57% . If the company can repeat this feat in 2012 (as it's on pace to do), the stock could be a whole lot cheaper than its P/E ratio suggests.

Cheap enough to buy? Actually, yes. I think it just might be.

Fool contributor Rich Smith has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend PetSmart. 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.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Diamond Foods, Inc. Stock Quote
Diamond Foods, Inc.
Marriott International, Inc. Stock Quote
Marriott International, Inc.
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