Friday's Top Upgrades (and Downgrades)

Analysts shift stance on Infosys, DreamWorks Animation, and Overstock.

Rich Smith
Rich Smith
Apr 25, 2014 at 11:31AM
Consumer Goods

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 ratings downgrades for DreamWorks Animation (NASDAQ:DWA) and (NASDAQ:OSTK). But the news isn't all bad. Before we get to those two, let's take a quick look in on why...

Infosys is rated "buy"
Markets are heading downward as the week draws to a close, with the Dow and Nasdaq both opening lower this morning. That's having a negative effect on shares of Indian outsourcer Infosys (NYSE:INFY) -- but it shouldn't.

At least, not according to analysts at investment banker Jefferies & Co., it shouldn't. Calling Infosys "one of the best delivery organizations, and it commands a 10-15% pricing premium over peers," Jefferies this morning announced it was initiating coverage of the IT outsourcer with a buy rating and a $60 price target. The analyst acknowledges problems with the stock, chief among them declines in profit margin and "volatile" revenue growth. But as the analyst sees it, expectations for Infosys' performance are now so low that "an improvement in either growth or margins would be perceived a positive" that would quickly drive the stock higher.

That's basically my read as well. Valued at 17.1 times earnings today, paying a 2% dividend yield and growing earnings at less than 15% annually, Infosys shares look only fairly valued. Meanwhile, free cash flow at the company ($1.55 billion) is trailing reported net income under GAAP ($1.75 billion). For the time being, I don't see any compelling reason to follow Jefferies' advice and buy the stock. If profit margins do turn up, or if growth does accelerate, then the stock would quickly begin to look undervalued, and justify a buy. My advice for now? Sit tight. Watch closely.

Time to underweight Overstock? 
Turning now to the day's bad news, we begin with, which reported a sizable "earnings miss" yesterday when Q1 profits of $0.16 fell short of the consensus target of $0.25 per share. Revenues were also light, and as a result, broker B. Riley has just announced it's taking down its price target on the neutral-rated stock to $19 -- a 32% reduction.

Now, optimists will note that even $19 a share is still slightly more than the $17 and change that Overstock shares sell for today. But even this small improvement may prove to be out of reach for the stock. The reason being that, while on the surface, shares look "cheap" at a P/E ratio of just 4.8, analysts believe that earnings are headed sharply downward, and will continue dropping over at least the next couple of years. The fact that already, the company is generating less than half as much real free cash flow ($37.4 million) as it claims to be earning under GAAP ($84.8 million) supports this view.

Valued on the $0.92 per share that Overstock is expected to earn next year, the stock sells for a forward earnings multiple of 18.6. While that might be a fair price to pay for a company that's growing smartly, Overstock is not growing. It's shrinking.

As a result, I don't think it's worth the $19 that B. Riley says it's worth, either.

Will DreamWorks ever wake from this nightmare?
Last and, in the opinion of one analyst, least, we come to cinema-quality cartoon maker DreamWorks Animation, juts downgraded by Topeka Capital to... sell. (Yes, an analyst actually used the "s" word.)

In unusually colorful language for an analyst, Topeka explained this morning that it is "cratering our price target" on DreamWorks stock, which Topeka now thinks is worth only $22 a share. This is versus the nearly $27 these shares sell for on the market today. And why is Topeka doing this?

Quoting from this morning: "We believe there is a very good chance DWA may recognize a substantial writedown on its current theatrical release Mr. Peabody & Sherman to the tune of $34.5mm, or $0.26/share in after-tax effects. If we are right, then that would be 3 of the last 4 films which have resulted in writedowns for DWA."

These writedowns have weighed heavily on DreamWorks already, to the extent that the stock now sells for more than 41 times earnings. Relative to analyst expectations of just 14% long-term profits growth, that's a very high price to pay for the stock. And the fact that free cash flow at DreamWorks is actually negative (and has remained so for the past three years) gives even less reason for optimism.

Long story short, Topeka's probably right to rate the stock a sell.

Rich Smith has no position in any stocks mentioned, and doesn't always agree with his fellow Fools. Case in point: The Motley Fool still recommends DreamWorks Animation.