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 an upgrade for Green Mountain Coffee Roasters (UNKNOWN:GMCR.DL), but downgrades for both Dell (UNKNOWN:UNKNOWN) and Consolidated Edison (NYSE:ED). Let's dive right in, beginning on a bright note as...
Green Mountain perks up
Our first notable ratings move of the morning is Green Mountain, which just won an upgrade to buy from Argus Research. Green Mountain shares currently cost $39 and change, which means that if Argus is right about its rating, the stock's move to $50 will give investors a better than 27% gain.
And Argus may be right about Green Mountain. Maybe.
Here's the thing: At 17.1 times earnings, Green Mountain shares definitely look cheap relative to long-term expected earnings growth of 18.6% per year. The problem with Green Mountain, historically, though, has been that the company's cash flow statement never really backed up the high "net earnings" the company was reporting. Free cash flow at the firm always seemed to range anywhere from negative to disastrously negative.
That changed a few quarters ago, though, when all of a sudden, Green Mountain began reporting positive free cash flow. At last report, the company was generating something on the order of $77 million in positive cash profits annually. Now, on the one hand, that's still a far sight short of the $363 million the company reports for its net income. On the other hand, though, the FCF number is finally moving in the right direction.
I don't know that I'd go as far as Argus does, to call Green Mountain a buy. At the very least, though, the stock is less of a clear-cut sell than it once was.
Is Dell a good deal?
Speaking of stocks that are, at their base, a free cash flow story: Dell. Yesterday, rumors began circulating of a possible going-private deal at Dell, spiking the shares 13% upward. And yes, at less than nine times earnings, and a mere seven times free cash flow, Dell shares certainly look cheap enough that you could see an acquirer wanting to take this one private.
Problem is, Dell has been cheap for quite a while, but no one's stepped forward and offered to buy it just yet. That has analysts at Monness, Crespi, Hardt & Co. suspicious of the shares' recent surge, and counseling caution about buying into it. The analyst cut Dell's rating to neutral this morning, at once capturing the profits from yesterday's price spike and stepping gracefully to the sidelines to see what happens next.
I think that's the right move here, too. Sure, on one hand Dell shares sell for low multiples to both earnings and free cash flow. But at the same time, they look appropriately priced for the mere 6% annual earnings growth that Wall Street expects the company to produce over the next five years. In fact, you can almost say that at seven times FCF, or more than eight times earnings, the stock is actually a bit expensive considering the slow growth rate.
In short, while it's possible private equity will step in and buy Dell, you probably shouldn't.
Don't buy the long Con, either
Last (and least), we come to electric and gas utility Consolidated Edison, recipient of a rather harsh sell rating from UBS this morning.
Wait -- did I say "harsh"? I meant "entirely appropriate."
Priced at 14.5 times earnings, ConEd may not look particularly expensive. With it paying a 4.3% dividend yield, you may even feel tempted to buy it. But you should resist that temptation, and I'll tell you why: Right now, analysts have ConEd pegged for less than 3% long-term annual earnings growth. When you add that growth rate to the stock's dividend yield, the total return ratio on this stock barely rises above 7%, which seems to me far too low for a stock that sells for more than 14 times earnings.
Add in the fact that ConEd generated just $304 million in real free cash flow over the past year -- versus a $1.1 billion reported "net profit" -- and the fact that the company carries well over $11 billion in net debt, and I'd argue that this stock is far more expensive than meets the eye. UBS is right to counsel selling it. That's advice you should heed.
Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Green Mountain Coffee Roasters.