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 upgrades for AOL (NYSE: AOL) and Simpson Manufacturing (NYSE:SSD), but it's not all good news. Read on, and find out why...
Fossil got buried
For shareholders of pop fashion watchmaker Fossil (NASDAQ:FOSL), the trading week is off to a bleak start. Earnings are due to come out tomorrow, but analyst Benchmark Capital is downgrading the shares (to "hold") ahead of the news.
Why? Two reasons, really: According to Benchmark, "retailers continue to report strong revenue in accessories and ... currency [exchange rates] moved in favor of Fossil during the quarter." For this reason, Benchmark says it's expecting Fossil to report better-than-consensus earnings tomorrow. Unfortunately, the rest of 2013 doesn't look so hot. The analyst worries that Fossil will announce below-consensus guidance for this fiscal year, perhaps prompting a sell-off tomorrow. When you consider that on top of this, the shares are already at Benchmark's $105 target price, the analyst thinks there's simply little upside left to be had.
And Benchmark is right about that. From a plain-vanilla PEG perspective, Fossil shares already look a bit pricey at 21 times earnings and an 18% growth rate. More worrying is the fact that over the past 12 months, real free cash flow at the company has significantly lagged reported net income -- $238 million in FCF versus $310 million in reported earnings. This indicates low quality of earnings at Fossil, and suggests we could see a potential "miss" in future quarters as earnings fall back toward FCF.
In short, Benchmark is right to be skeptical of Fossil today. You should be, too.
AOL back online
Happier news awaited AOL investors on Monday, as shares that leapt 14% Friday on a strong earnings report are getting a secondary bump from an upgrade (to "outperform") at RBC Capital. Meanwhile, fellow analyst Jefferies is adding fuel to the fire with a research note predicting AOL shares will hit $50 within a year.
According to StreetInsider.com, which reported the price target hike at Jefferies this morning, the analyst thinks "AOL's core assets are being underappreciated and ... this story continues to get better."
There's some truth to that. Last year, as you may recall, AOL's "core assets" turned into a big score for the company, which offloaded some 800 patents to Microsoft in a $1.1 billion sale. On the other hand, this big one-time windfall is currently distorting AOL's income statement, making it look like the stock has a P/E of 3. That's quite low for the 27% long-term growth rate analysts assign AOL. And yet, if you look out a year, you'll notice that the forward P/E ratio on AOL is closer to 20. That's not as cheap as 3, granted. But it's still not expensive if AOL manages to grow earnings at 27% a year for the next five years -- as the analysts are promising it will.
In short, the analysts are probably right to be optimistic about AOL's chances. Once left for dead, this stock has a new lease on life, and, well, like the analyst said: "This story continues to get better."
Don't have a cow -- but they just upgraded Simpson Manufacturing
In our third and final rating of the day, we find investment banker D.A. Davidson announcing an upgrade for screws and fasteners maker Simpson Manufacturing. It's not the sexiest of businesses, but in a reviving housing market, it's a logical place for investors to look in hopes of making some profit. Davidson thinks this $30 stock is worth $37. But honestly, I'm not so sure it's right -- not nearly as certain as I am about the other two ratings we've looked at.
Why not? Well, just look at the valuation: Priced at 34.5 times earnings already, Simpson has all the expectations for 15.5% long-term earnings growth priced into its stock already -- and more. Meanwhile, what did we see at Simpson in 2012? The company reported its 2012 performance just last week, with revenues rising 9%, but profits falling 16%.
Neither of these numbers, you'll notice, is anywhere near the average 15.5% gain that Wall Street has been promising us. But even if it were, it would still be hard to see why investors would willingly pay 34 times earnings for that growth rate.
Long story short, Davidson is wrong to be long Simpson. In fact, at today's prices, the stock might make for an even better short idea.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Fossil and Simpson Manufacturing. The Motley Fool owns shares of Fossil and Microsoft.