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 feature upgrades for a pair of semiconductor firms, Intel (INTC +2.20%) and ARM Holdings (ARMH +0.00%). But the news isn't all good.
Attaching a neutral rating to Staples
Early this morning, investment megabanker J.P. Morgan announced it is pulling its overweight rating on Staples (SPLS +0.00%), and downgrading the shares to neutral on fears of "secular pressures" hurting the office supply retail market. Staples shares currently cost a bit less than $14, and while J.P. thinks they're actually worth closer to $15, nonetheless, the difference between price and value here doesn't seem to be big enough to keep the banker interested in buying Staples shares.
But is J.P. overlooking an opportunity?
I think so, yes. Consider: With negative GAAP earnings today, and a fair amount of debt on its books, there's plenty of reason to be leery of Staples shares today -- and I don't blame J.P. a bit for being nervous. That said, Staples still has the nation's No. 2 e-commerce website. It's generating plenty of free cash flow ($963 million over the past year), and its stock costs less than 10 times this FCF number. The company pays a pretty generous dividend yield for a retailer -- 3.4% -- and is currently being priced like its 4% long-term projected growth rate is a given.
My hunch: If Staples can find a way to grow even a little bit better than that -- by stealing share from Office Depot-Max as they're busy consummating their merger, perhaps, or by taking advantage of Amazon's increasing subjection to state sales tax laws to compete more strongly with it on price -- Staples shares could turn out to be a steal at today's prices.
Time to give ARM a hand?
Turning now to the day's upgrades, mobile chipmaker ARM Holdings scored an upgrade to "buy" at the hands of Deutsche Bank.
Noting that ARM shares have fallen 20% since their May 2013 peak on worries of "market share loss to Intel following its new Silvermont mobile architecture launch and winning a tablet design with Samsung" and fears of "slowing high-end smartphone growth" overall, Deutsche is calling a bottom on the stock today. Quoted on StreetInsider.com this morning, the German banker suggested that "even if Intel gains 10% unit share by 2016," and even if "a high-end slowdown" does materialize, investor worries over ARM's valuation are still overdone.
I disagree. Priced north of 80 times earnings, and selling for nearly 63 times trailing free cash flow, ARM needs to grow its profits at least three times faster than the 22% annual growth rate that Wall Street is projecting for it in order to be fairly priced. Long story short, Deutsche is right that ARM remains a great business, with a great future -- but the stock simply costs too much to be worth buying today.
A more Intel-ligent investment
And what about the company making investors so nervous about ARM? Intel, too, scored an upgrade this morning, this time courtesy of Argus Research. Argus now rates Intel a buy, and has hung a $28 price target on the stock -- and this time I think Wall Street is right on the money.
Priced below 12 times earnings, and expected to grow these earnings at 11% annually over the next five years, boasting strong trailing free cash flow of $10.9 billion (15% better than reported earnings), and paying 4% dividend yield, Intel is a large cap tech star selling for a bargain price.
Argus is exactly right to recommend buying it. Full stop.
Motley Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Intel and Amazon. The Motley Fool owns shares of Intel, Amazon, and Staples.
