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Tuesday's Top Upgrades (and Downgrades)

By Rich Smith - Apr 16, 2013 at 2:42PM

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Analysts shift stance on Thermo Fisher, Dreamworks, and Baidu.

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 both Thermo Fisher Scientific (TMO 5.97%) and DreamWorks (DWA). But it's not all good news. Turns out, despite projections of 43% revenue growth in Q1, one analyst is busy ...

Downgrading Baidu
 "China's Google," Baidu (BIDU 2.13%), is set to report Q1 results on April 25 . Analysts are looking for 18% growth in earnings per share to $1.03, and even speedier performance on revenue growth, expected to top 43%. Regardless, one analyst -- Maxim Group -- is doubling down on its "sell" rating on Baidu and cutting its price target to $75. Is this a mistake?

I think it is, yes.

While there are certainly concerns about the pace of Chinese growth in general, Baidu itself looks pretty strong to me -- and certainly value-priced. The stock costs only 19 times earnings, and if it's true that free cash flow at Baidu ($1.5 billion) hasn't measured up to GAAP earnings ($1.7 billion) lately, then it's still true that Baidu's 20x price-to-free cash flow ratio looks cheap relative to expectations of 30% long-term annual profits gains.

Fact is, if all Baidu manages to produce this month is the 18% profits growth that's expected of it, the stock still looks close to fairly priced given its cash reserves. Accordingly, Maxim's warning of an imminent 17% sell-off in the stock looks overblown.

Is this new DreamWorks upgrade a pipe dream?
 Meanwhile, over at institutional broker B. Riley, it's all happy talk and upgrades about DreamWorks Animation this morning. Flipping from a "sell" rating on the stock to a "buy," Riley appears convinced that DreamWorks will hit a big payday with its upcoming sequel How to Train Your Dragon 2, and is urging investors to buy the stock ahead of a big run-up -- all the way to $23.

But I say that's bunk.

Unprofitable today, and burning cash (as it's done continuously for the past two years), DreamWorks' current financial numbers have little to recommend them. Fact is, even if Riley is right about How to Train Your Dragon 2, and DreamWorks returns to profitability next year, the stock's 22x forward P/E ratio already prices in the chance of this success, and the stock's 17% projected long-term growth rate remains too low to justify the P/E.

And that's if everything goes right with the new film. If How to Train Your Dragon 2 bombs, as so many sequels do, DreamWorks stock could wind up looking even more overpriced "tomorrow," than it already does today.

A rare buyout upgrade
Finally, medical equipment maker Thermo Fisher Scientific is enjoying a second straight day of gains after announcing its megabillion-dollar buyout of Life Technologies (NASDAQ: LIFE) early Monday. An upgrade to "buy" from Mizuho Securities this morning is adding fuel to Thermo Fisher's Bunsen burner, but is this stock as hot as it's being made out to be?

I certainly don't think so. Viewed on its own, Thermo Fisher's 25x P/E ratio and 11% projected growth rate seem anything but cheap. (Albeit the company's strong free cash flow number -- $1.7 billion -- suggests the stock's not quite as overpriced as it looks). And as for the company it's buying, Life Tech isn't all that great a deal, either.

Valued on earnings, Thermo's presumed new subsidiary costs more than 30 times GAAP profits, which seems quite a lot to pay for sub-10% earnings growth. True, like Thermo Fisher, Life generates superior free cash flow ($661 million last year). But again, it's not so amazingly free cash flow positive as to justify the price Thermo is paying for it -- more than 19x FCF. Nevertheless, Thermo Fisher appears to be overpaying for its acquisition, anteing up 3.3 times annual sales for its prize, a good 50% premium over the 2.2-times-sales valuation its own shares command.

Put simply, Thermo Fisher was no bargain before it agreed to buy Life. It's getting no great bargain when it buys Life. And the two companies, combined, will be just as overpriced as each of them was before, separately.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Baidu, DreamWorks Animation, and Thermo Fisher Scientific. The Motley Fool owns shares of Baidu.

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Stocks Mentioned

Baidu, Inc. Stock Quote
Baidu, Inc.
BIDU
$139.09 (2.13%) $2.90
DreamWorks Animation SKG Inc. Stock Quote
DreamWorks Animation SKG Inc.
DWA
Thermo Fisher Scientific Inc. Stock Quote
Thermo Fisher Scientific Inc.
TMO
$572.35 (5.97%) $32.24

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