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 NetSpend (UNKNOWN:NTSP.DL), a downgrade for NVIDIA (NASDAQ:NVDA), and for Whole Foods (NASDAQ:WFM), a lowered price target.
Good news first
Starting the day's news on a bright note, NetSpend shareholders can rejoice in the fact that analyst Compass Point no longer thinks their stock is a "sell." Yesterday, the prepaid card provider announced earnings that met analysts' estimates ($0.15 per share) and revenue that beat it. The company also said it expects to earn greater that $0.76 a share this year, also ahead of consensus. Upgrading to "neutral" this morning, Compass relented on its target price as well, doubling the target and saying NetSpend is now worth about $10 a share.
That's the good news. The bad news is that NetSpend shares currently cost $12 -- suggesting there's still significant downside risk in the stock. And the worse news is that Compass is probably right.
Priced at 45 times the $19 million it earned last year, NetSpend shares quite simply cost too much -- even if the company hits Wall Street's projected growth rate of 18%, and probably even if it beats it. In short, while Compass Point's decision to relent on its sell rating is understandable given yesterday's earnings beat, and NetSpend's upbeat guidance... the analyst was still right the first time around, and NetSpend still deserves that "sell" rating.
Whole Foods spoils
Speaking of companies that cost too much: Whole Foods reported $0.78 per share in profits yesterday evening, beating estimates by $0.01. It also reaffirmed fiscal 2013 guidance of $2.83 to $2.87 a share in profit. So naturally... investors sold off the stock.
I know, it doesn't seem to make sense, but only until you realize that at its recent valuation, Whole Foods was priced for perfection. The mere strong performance it demonstrated yesterday wasn't enough to support the stock price. So this morning, RBC Capital Markets did the logical thing and reduced its target price on the stock to $100.
Now here's the problem: A $100 stock price is still 14% ahead of where Whole Foods trades right now. And right now, Whole Foods is still overpriced. While the company's certainly growing fast enough at an annualized rate of 19% (projected), that's simply not fast enough to justify the 33 times earnings valuation that Whole Foods shares still command. It's even less likely to support the 35 times free cash flow valuation on the stock, which generates significantly less real cash profit than it reports as its "net income" under GAAP. And as for the stock going up another 14%, as RBC still insists it will? Dream on.
And finally, we come to our featured downgrade of the day: NVIDIA. StreetInsider.com reports that the semiconductor maker beat analyst estimates soundly yesterday, reporting $0.35 per share in fiscal Q4 2013 profit versus estimates of just $0.30, and beating on revenue as well. The problem here is that when guiding on fiscal Q1 2014 revenues (that's this current calendar quarter, by the way), NVIDIA says it is looking for only about $940 million -- far below the $1.07 billion Wall Street was projecting.
Citing a litany of complaints that begin with the weak guidance (but don't end there), investment banker Needham downgraded NVIDIA shares to "hold" this morning. According to the analyst, "lack of meaningful Tegra growth," plus "limited traction in smartphones, lackluster sell-through of MS Surface Tablet RT tablets, and share loss to QCOM in Android-based tablets" all add up to a prediction that this stock will "trade flat for the foreseeable future."
And Needham may be right about that. Based on the company's most recent earnings, NVIDIA shares now cost about 13.7 times trailing earnings. That's right about what you'd expect to pay for a projected 11% long-term grower with a 2.4% dividend yield like NVIDIA.
Granted, the company has a lot of cash on its balance sheet -- $3.4 billion -- almost no debt at all, and superb free cash flow. (All these are reasons why I own NVIDIA myself.) But if the company can't put that cash to effective use to grow earnings, NVIDIA stock could indeed remain stuck in neutral for some time to come.
Motley Fool contributor Rich Smith owns shares of NVIDIA. The Motley Fool recommends NVIDIA and Whole Foods Market. The Motley Fool owns shares of Whole Foods Market.