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 downgrades for both Whole Foods (WFM) and Finish Line (FINL). There's some good news, too, of course...
Overoptimistic about Under Armour
Well, sort of good news. This morning, Janney Capital Markets announced they're raising their price target on Under Armour (UAA 1.81%). The analyst still doesn't recommend buying the stock, mind you. But they do think it's worth a bit ($2) more than they used to -- $56 a share, to be precise -- and that's about 11% more than the shares cost today.
But is Janney right?
With UA shares having underperformed the S&P 500 by more than 9 percentage points over the past year, a lot of shareholders will be hoping Janney's right. Unfortunately, they're likely to be disappointed. While it's a fine company, and a fine business in its own right, the sad fact is that UA shares remain woefully overpriced already, and unlikely to gain much in value.
The good news about UA is that the company is finally generating free cash flow again, and indeed, generating more free cash than it currently reports as its "net income" under GAAP. Yet even so, priced at 42 times earnings, and paying no dividend, UA costs about twice what you'd expect a company growing at 21% (as UA is) to go for. As a result, while I'm no longer as pessimistic about UA as I used to be, the simple truth is that Janney's half-right about the stock: It may be worth more than it used to be, but it's still not cheap enough to risk buying.
Whole Foods is half-bad
Now let's see if we can find more value in the stocks that Wall Street is downgrading. First up is Whole Foods, which got clipped by a downgrade to neutral from Piper Jaffray this morning, and is leading the supermarket sector lower. Piper sees sales growth and margin expansion slowing at the organic foods retailer, and this throws into question Wall Street's assumption that Whole Foods will be able to grow its profits at 19% per year over the next five years.
When you consider that Whole Foods was already looking pretty pricey at a P/E of 32, and 19% growth, the suggestion that Whole Foods might actually grow even slower than this is causing some justifiable nervousness among investors.
Once again, what we have here is a truly terrific company, and one with strong cash profits-production, selling for a price that's just too rich for the company's performance to support. While I won't say the stock looks doomed, I do agree with Janney that it costs too much to buy.
Down to the Finish
Finally -- and appropriately -- let's finish up with Finish Line, easily the worst-faring stock on today's list as it gets hit with a downgrade to underperform by the analysts at Sterne Agee, and sees its stock fall more than 4% in response.
Sterne's worried that Finish Line is "losing share to Foot Locker," you see. The analyst's also decidedly unimpressed with Finish Line's decision to open stores-within-stores at Macy's department stores, and warns that this move "will likely harm the Finish Line brand identity." Add in expected costs growth as Finish Line revamps its digital store, and Sterne sees earnings coming in lower than expected both this year and next -- $1.41 and $1.55 a share, respectively.
These numbers are considerably worse than the $1.48 and $1.63 that most folks on Wall Street were expecting, which explains why folks are fleeing Finish Line stock today. Finish Line looks fairly priced at its current valuation of 12 times earnings and an 11% growth rate (with a 1.5% dividend to make up the difference), after all. If the valuation's going to rise to 13 times earnings later this year, though, then that's a bit iffier. Plus, Finish Line's looking a lot less healthy on cash production. If the company reported "earning" $79 million last year, it only generated real cash profits of about $11 million.
Long story short, although Finish Line is technically the "cheapest" stock on today's list, it's not cheap enough to buy -- and won't be. Not until it gets its costs under control, and starts generating more cash.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Under Armour and Whole Foods Market. The Motley Fool owns shares of Under Armour and Whole Foods Market.
