Please ensure Javascript is enabled for purposes of website accessibility

Thursday's Top Upgrades (and Downgrades)

By Rich Smith – Jul 18, 2013 at 3:36PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Analysts shift stance on SanDisk, Johnson & Johnson, and HollyFrontier.

This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, as earnings season gets under way in earnest, analysts are busy tweaking their price targets to track changes in earnings and guidance. We'll be taking a look at three such tweaks today, for popular stocks: SanDisk (NASDAQ: SNDK), Johnson & Johnson (JNJ), and HollyFrontier (HFC).

Good news first
Let's take these in order, beginning with SanDisk, which is up more than 2% today after reporting $1.06 per share in profits on $1.5 billion in revenues -- beating analyst estimates on both counts. Speaking of counts, the number of analysts upping their price targets on the stock had reached five at last count, with Needham & Co. leading the pack with a projection of $80 a share.

That target is close to $20 above where the shares now trade, suggesting a potential 31% profit in the stock. But can investors realistically hope to capture those profits?

Yes, it very well might. SanDisk turned in a truly magnificent quarter yesterday. Thanks to the beaucoup profits, the company's P/E ratio now stands just a hair below 21 -- versus the near-31 times earnings valuation still being shown on Yahoo! Finance's key statistics page. If the company succeeds in hitting the 28% annualized, long-term growth estimate that analysts have it pegged for, 21 times earnings is an absolute steal of a deal on this stock. Plus, with trailing free cash flow now clocking in at $940 million -- versus "only" $718 million in GAAP net earnings -- this stock's arguably even cheaper than it looks.

Fact is, at a price-to-free cash flow ratio of less than 16 today, I think SanDisk will be a great bargain if the stock even posts growth in the upper teens over the next five years. If it gets into the 20-percent range, though, look out ... above!

Paging Dr. Profit
In contrast, I'm less enthused about Johnson & Johnson, the buy rating Argus Research is still assigning it, and the new $104 price target Argus has suggested.

Don't get me wrong. Johnson & Johnson's report yesterday was fully as good as SanDisk's with revenues ($17.9 billion) and per-share profit ($1.32) both beating expectations. My objections to this stock center less on the success of the business, and more on the price that investors are being asked to pay to own a piece of that business.

Simply put, Johnson & Johnson shares cost too much. Based on the most recent data the company has provided us (which does not include free cash flow data, tsk, tsk), Johnson & Johnson shares now trade for nearly 20 times earnings. That's quite a lot to pay for a company that few analysts see growing earnings at much more than a 6% annualized rate over the next five years.

In fact, even Johnson & Johnson's generous 2.9% dividend yield isn't enough to entice me to buy these shares. As great a company it may be, Johnson & Johnson's stock price is a prescription for portfolio underperformance.

And speaking of underperformance...
One of the very few stocks getting hit with a reduction in price target today is oil refiner HollyFrontier. Over at Imperial Capital, analysts just cut $10 off their target price for Holly shares. (And Holly didn't even report earnings yesterday).

The reason: As Motley Fool Blog network writer Sarfaraz Khan recently pointed out, a marked contraction in the difference in prices between West Texas Intermediate (WTI) crude oil and that of Brent is putting the squeeze on refiners like Holly. In years past, these refiners have been able to buy WTI crude oil at steep discounts, refine them into gasoline and diesel, and sell them at prices more approaching to what other refiners had to charge after refining pricier Brent crude oil.

Those days are coming to an end, and with them, the tailwind that's been boosting HollyFrontier's profits. As a result, the P/E at Holly that today sits below 5.0 is expected to spike sharply upwards next year, giving the stock a forward P/E ratio of nearly 8.5. Indeed, already, we can see foreshadowing of this effect on the company's cash flow statement, where free cash flow numbers for the past 12 months ($1.3 billion) are coming in about half-a-billion dollars below reported net income numbers ($1.8 billion).

Mind you, despite cutting its price target on Holly, Imperial Capital isn't actually counseling selling. To the contrary, Imperial retains a buy rating on the stock, and the reason here is clear: Holly remains cheap, even if earnings falter a bit.

The stock costs only 6.5 times free cash flow today, and the company is sitting on $1.2 billion in net cash (reducing its valuation even further). If earnings aren't going to grow much -- or don't grow at all -- over the next few years, at least the stock is cheap enough to "price in" that risk. Meanwhile, we know that growth will return... eventually. At this point, investors may just want to sit back, cash their 2.8% dividend checks, and wait out the slump.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson.

None

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Johnson & Johnson Stock Quote
Johnson & Johnson
JNJ
$163.20 (%)
HollyFrontier Corporation Stock Quote
HollyFrontier Corporation
HFC

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
326%
 
S&P 500 Returns
102%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 10/04/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.