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 a downgrade for Advanced Micro Devices (NASDAQ:AMD), but an upgrade for Taser (NASDAQ:AAXN), and a better price target for Smith & Wesson (NASDAQ:AOBC).
Let's start at the top with the analyst who's just turned...
Stock markets are enjoying an early Santa Claus rally today, but shareholders of semiconductor giant Advanced Micro Devices are getting nothing but coal. Shares are down more than 2% as of this writing, after the stock got hit with a ratings downgrade to "underperform" from investment banker Oppenheimer. Which is curious, because...
As Oppenheimer admits, AMD has won some sizable contracts in the gaming console space, and its core market in PC chips is "stabilizing." Nonetheless, the analyst worries that AMD's profitability is at risk as "Intel leverages its vast manufacturing and cost advantage to aggressively and profitably capture low-end share," while NVIDIA maintains a stranglehold over graphics chips.
Indeed, AMD's gross margins have been slipping these past couple of quarters, falling sequentially from 40.9% in Q1 2013 to 39.5% in Q2, and most recently hitting 35.7% in Q3. The company's currently net-unprofitable under GAAP accounting standards, and once again burning cash, with free cash flow ringing in at negative $540 million for the past 12 months. Debt load is also high, at $1.2 billion, and growth prospects -- 8% annually over the next five years, according to analysts -- is less than half the average projected earnings growth rate for other members of the industry.
Long story short, Oppenheimer may be right to be going short on AMD.
Now let's move on to the good news.
We start with Taser, the stun-gun maker that just won an upgrade to "overweight" from JPMorgan. Last week, Taser won a place on Glassdoor's list of the 50 best places to work in America -- and today, it's looking like a good place to be invested as well. Taser shares are up nearly 9% in response to JP's upgrade.
Granted, at a price-to-earnings ratio of 53, some may question whether there's any more room left for Taser to run. But consider: Taser generated about 48% more cash profit over the past year than it was permitted to claim as "net income" under GAAP -- $24.7 million FCF versus $16.7 million reported profit. That's enough cash to give the stock a price-to-free cash flow ratio of about 35 -- not too far above the company's projected 30% long-term earnings growth rate. On balance, I think the price is now probably a bit too high to justify following JP's advice and buying Taser stock. But in one respect, at least, JP is right: Taser is not as expensive as it looks.
I'd keep an eye on this one, with an eye to buy if and when the post-upgrade bump in stock price fades away.
Smith & Wesson clicks
Finally, we come to Smith & Wesson, which last week announced Q2 earnings results that beat expectations, then followed that up with a reiteration of guidance for the rest of the year -- $610 million to $620 million in sales, and profits per diluted share of $1.30 or better on these sales.
Today, this promise of further good news as the fiscal year progresses is winning Smith & Wesson a fan on Wall Street, as The Benchmark Company increases its price target on the company to $16 -- a 23% bump.
On the surface, that looks like the right call. Priced at less than 10 times earnings today, Smith & Wesson resembles Taser in that analysts have it pegged for 30% annualized earnings growth over the next five years. That relationship between P/E and growth rate actually argues in favor of raising the price target on S&W higher than Benchmark is doing.
The one quibble I have with the stock, however, is that despite strong reported earnings, the company's currently burning cash. Here at the halfway mark of its fiscal year, free cash flow is a depressingly negative $2.1 million. This fact suggests S&W's "earnings" may not be quite as good as they appear, and argues in favor of caution on the stock. At the very least, when valuing it, I'd suggest investors focus on the company's $57 million in trailing free cash flow (last year's H2 was stronger than this year's H1 has been), rather than the GAAP number of $79 million in "profit."
The resulting valuation -- 12.3 times FCF -- still tells me that Benchmark is probably right to recommend Smith & Wesson stock. But if S&W produces a second quarter of negative free cash flow in Q3, my opinion on that score could change in a hurry.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.