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Wednesday's Top Upgrades (and Downgrades)

By Rich Smith - Apr 10, 2013 at 12:05PM

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Analysts shift stance on IBM, Toyota, and Netflix.

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 new buy ratings for IBM (IBM 2.19%) and Toyota Motor (TM 0.31%). But it's not all good news, so let's start off with a look at why one analyst is ...

Pulling the plug on Netflix
Stock markets are up this morning, but over at Netflix (NFLX 2.04%), all investors are seeing is a static. Thanks in part to an initiation at "underweight" by Evercore Partners today, Netflix shares are sitting out the rally, and actually are down a fraction of a percent in late morning trading.

Why? In a word: competition. Evercore worries that even if it was the top dog and first mover in streaming video, the market is big enough to support more than one major player. If Netflix has to contend with one or more rivals, it will have to bid higher prices to license content from creators. This will raise the company's cost of business. Meanwhile, price competition on the delivery end will prevent the company from passing higher content costs on to consumers. Thus, Netflix will see its profit margins squeezed on both ends.

All of this adds up to limited potential from profit growth at a company whose shares already cost 575 times earnings. With a 20% expected growth rate, that share price was always in danger. Now, Evercore is warning investors that the danger is even greater than we thought. The analyst thinks it's best to lighten up your exposure to Netflix now, and I agree.

Go big with Big Blue? 
Looking for a better bargain? UBS thinks it's found one in the shares of IBM, which the Swiss banker just upgraded to buy Wednesday morning.

The analyst here thinks IBM shares could be worth $235 within a year, and while I don't think UBS is right about that, it's at least in the ballpark. Here's why:

IBM shares currently cost about 14.7 times earnings. That's not a whole lot to pay for a stock growing earnings at close to 11%, and paying a 1.6% dividend. On the other hand, though, IBM isn't generating quite as much cash as its income statement suggests. It generated only about $15.5 billion in true free cash flow last year, versus reported "net income" of $16.6 billion. Large numbers either way, but the one isn't as big as the other, and to me, this suggests that IBM's about 7% more expensive than it looks -- or even more, once you factor the company's $22 billion debt load into the picture.

All in all, I see IBM as a great company, but one that's not worth the 16.5 enterprise value to free cash flow ratio that its current share price implies. While UBS's promised 10%, one-year profit from the shares could happen, I wouldn't bet on it.

Have you driven a [Toyota] lately?
Toyota and Ford (F 2.80%) are feuding today over Ford's claim that its "Focus" became the world's top-selling sedan in 2012. (Toyota says the winner is Corolla). This morning, though, analysts at Guggenheim came out firmly in favor of the incumbent.

Regardless of whether Ford took top honors for sales of a single class of car, Guggenheim thinks Toyota stock is a buy, and initiated coverage of Toyota with this rating Wednesday. But is Guggenheim right?

On the surface, the case seems open and shut. Toyota shares, at 17.6 times earnings, cost nearly twice as much as Ford at a 9.1 P/E. Toyota's also carrying a bigger debt load, and paying a dividend yield less than half of Ford's generous 3.1% payout. Advantage: Ford.

On the other hand, Toyota has a few factors in its favor as well. The company generated $6.6 billion in positive free cash flow last year, which was nearly twice Ford's $3.6 billion cash haul. And most analysts polled see Toyota growing its profits in excess of 40% per year over the next five years as it rebounds from a sales slump, and capitalizes on an export-friendly, weakened Yen. Ford's projected growth rate, in contrast, is a relatively plodding 10.5%.

In short, if growth estimates prove out in both cases, Guggenheim probably has a point here. Ford looks like the cheaper stock today -- but Toyota's future is brighter.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Ford and Netflix. The Motley Fool owns shares of Ford, International Business Machines, and Netflix.


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Stocks Mentioned

International Business Machines Corporation Stock Quote
International Business Machines Corporation
$137.99 (2.19%) $2.96
Netflix, Inc. Stock Quote
Netflix, Inc.
$190.32 (2.04%) $3.81
Ford Motor Company Stock Quote
Ford Motor Company
$13.41 (2.80%) $0.36
Toyota Motor Corporation Stock Quote
Toyota Motor Corporation
$159.71 (0.31%) $0.50

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