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 belated upgrade for Acme Packet (UNKNOWN:APKT.DL), alongside downgrades for both Cree (NASDAQ:CREE) and American Science & Engineering (NASDAQ:ASEI).
Cree must crumble
We begin the day on a down note, as Maxim Group takes an axe to its own buy rating on LED specialist Cree, and cuts the stock down to hold.
It's an inauspicious development for new Cree CFO Mike McDevitt, who just got confirmed in his post yesterday -- but it's probably also a deserved downgrade. After all, the company's shares already cost more than 91 times earnings. Having gained more than 50% in value over the past 12 months already, it's hard to see where they can go from here (except down).
Indeed, viewed under even the most favorable light, Cree's strong free cash flows and copious cash reserves are still only good enough to give the stock an enterprise value-to-free-cash-flow ratio of 18.5. And while that's a better-looking number than "91," it's still a bit too high for the 16% annual profits growth that Wall Street expects Cree to produce over the next five years. While I think there's an argument to be made in favor of Cree's shares being fairly valued today (and indeed, that's what a hold rating is supposed to mean), I don't see enough value left in the shares to recommend buying them.
American Science is better than it looks
In contrast, a stronger case can be made for investing in shares of "Backscatter" X-ray maker American Science & Engineering -- despite the fact that it, too, is getting downgraded on Wall Street today.
This morning, analysts at Benchmark cut their rating on AS&E stock to hold, citing government delays in making orders, and a too-high valuation. Analysts, on average, project 15% annualized profits growth for AS&E over the next five years, but Benchmark warns that "AS&E will struggle to grow in FY13 and possibly in FY14 due to soft bookings from government delays and economic uncertainty." Meanwhile, with a valuation of "10.4x our FY14 EV/EBITDA," Benchmark sees AS&E costing more than "the sector average of 7x, while we think AS&E has limited visibility for growth and faces potential margin compression from product diversification and competition."
That all sounds pretty bad, I'll grant you. But here's the thing: AS&E generated well over $36 million in real cash profit over the past 12 months. If you value it on its enterprise value and free cash, therefore, what you come up with is an EV/FCF ratio of just 11.2. So arguably, AS&E doesn't really have to hit the 15% growth rate that Wall Street has it pegged for to be worth buying at today's levels. Indeed, anything more than about an 11% growth rate should suffice -- or even less than 11%. Remember that AS&E is currently paying a dividend of nearly 3%. Once you factor that into the valuation picture, it's actually easy to see the stock as "buyable" at anything over an 8% growth rate.
In short, Benchmark may be right about AS&E not growing as fast as Wall Street thinks it will. Fortunately, the stock doesn't have to grow anywhere near that fast to give investors a good bargain.
Packing it in on the Acme Packet short
And finally, a bit of good news for long-suffering Acme Packet shareholders. Even after yesterday's price spike in response to Oracle's (NYSE:ORCL) buyout offer, your shares may still be down 15% over the past year -- but at least it shouldn't get any worse.
This morning, one of the bears who've been chewing on Acme through its long downturn finally turned around, and upgraded the stock. Why? Acme may still cost 360 times earnings, and may be dreadfully overpriced as a stand-alone company, but according to Mizuho, the fact that Oracle has signed on to put Acme shareholders out of their misery means the stock can't fall any farther.
Mizuho is declaring victory, closing out its short call, and upgrading Acme to neutral. It's an obvious call, sure, but probably still a welcome relief for Acme fans.
Motley Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Acme Packet. The Motley Fool owns shares of Oracle.