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 lowered ratings at Dominion (D 0.77%) and Deckers Outdoor (DECK 0.45%), but a 180-degree reversal to the upside, as one analyst opines:
MercadoLibre? Buy it now!
Shares of MercadoLibre (MELI -1.49%) -- the "Argentinean eBay" -- skyrocketed in Friday trading after the online auction house reported Q4 earnings far exceeding estimates. The $0.93 per share that MercadoLibre reported earning last quarter was $0.15 ahead of expectations, and the company's revenues, $134.6 million, beat expectations as well.
Commenting on the results, CEO Marcos Galperin noted that "strong fourth quarter results showed positive momentum in marketplace and payments as we kept driving improvements to user experience. I look forward to more innovation in 2014..." He's not the only one. Following the release of the report, analysts at Stifel Nicolaus did a quick 180 on their opinion of the stock, removing their sell rating and replacing it with a buy. But I think they jumped the gun.
MercadoLibre's earnings number looked impressive, no doubt, from a GAAP perspective. But the company's quality of earnings remains exceedingly low. Free cash flow for the year amounted to less than $29 million, a steep decline from 2012 levels and barely enough to give the company $0.24 in real cash profits for every $1 in claimed "earnings."
As a result, if the stock looks expensive to you at 40 times GAAP earnings, it's downright outrageous when valued on free cash flow -- trading for a multiple to FCF of 163. Even if the company succeeds in growing earnings at the 25% growth rate that analysts project, it's hard to see how these multiples to earnings and free cash flow could be justifiable.
And speaking of steeply priced stocks...
Deckers Outdoor is clearly another one. I warned against investing in this overpriced stock last month, and now investors are seeing why. Despite "beating earnings" every bit as soundly as MercadoLibre just did ($4.04 per share earned in Q4, or $0.26 better than predicted), Deckers shares are slumping 13% on worries that the company's having to spend too much to keep its growth going.
This morning, analysts at Jefferies & Co. cut their rating on the stock to hold and sliced 25% off their price target (now $75) in response to an "overly aggressive spending plan for 2014 and a softer than expected revenue outlook" that the company announced with its earnings release. Their peers at Goldman Sachs likewise highlighted "management's continuous need to invest" as a danger to the shares, and noted that Deckers' promises of a revenue growth rate "in the low-double digits" seem out of line with what other shoe retailers are projecting. Thus, the company may be overly optimistic.
However much it ultimately grows sales, most analysts doubt Deckers will be able to achieve anything more than high-single-digit earnings growth over the next five years. Given this, the company's P/E ratio of 17.5 looks steep. Combined with debt levels that are high and free cash flow often lagging net income, it's unlikely this stock will outperform the market going forward.
Last and least, we come to Dominion, our only stock downgrade. This one got cut to hold at Argus Research this morning following an 18.5% run-up in stock price since September. Flyonthewall.com says the downgrade was a "valuation" call, and if that's the case, it's easy to see why Argus might be nervous.
Unprofitable over the last 12 months, and burning cash for even longer than that, Dominion shares sell more than 18 times next year's potential profit -- despite having a projected earnings growth rate of less than 7%.
The company hasn't generated a penny's worth of free cash flow since 2001, but it's built up a boatload of debt -- more than $23 billion worth, against just $316 million in cash. While an essential utility, and unlikely to ever actually go "out of business," as a business, Dominion is no great shakes. Argus is right to downgrade it.
Motley Fool contributor Rich Smith has no position in any stocks mentioned, and doesn't always agree with his fellow Fools. Case(s) in point: The Motley Fool recommends Dominion Resources. It recommends and owns shares of MercadoLibre.