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 pair of new buy ratings for bankers Fifth Third Bancorp (FITB 2.64%) and JPMorgan Chase (JPM 2.13%). Before we get to those two, though, let's take a quick look through the windows at Restoration Hardware (RH 4.24%), and find out what's going on in there.
Hard news for Restoration Hardware
Shares of the home furnishings retailer followed the market down on Monday, off more than 1 percentage point in early afternoon trading. For this, you can (in part) blame BB&T Capital, which just downgraded the stock to neutral.
Restoration Hardware shares are up 25% over the past 52 weeks, racking up about half-again the gain of the S&P 500. Problem is, this leaves the company vulnerable to accusations that it has become overvalued -- and that's just what BB&T said about the stock today.
With the stock priced at a staggering 189 times earnings, the accusation is not without merit. Even though most analysts who follow the stock think Restoration Hardware has bright days ahead, and will grow earnings north of 26% annually over the next five years, 189 times earnings is a hard price to swallow -- especially once you realize that these "earnings" are basically illusory.
According to Restoration Hardware's cash flow statement, while the company reported "earning" $20 million worth of "profit" over the past year, it actually burned through more than $50 million in cash. Indeed, according to data from S&P Capital IQ, this company has been free-cash-flow negative for the past four-and-a-half years. With cash flow trending lower than last year, and capital spending trending up, there seems little chance we'll see any immediate improvement in Restoration Hardware's negative FCF number.
Long story short, I think BB&T is right to downgrade the stock. Seems to me, Restoration Hardware shareholders are looking forward to some hard times ahead.
Should you bank on Fifth Third?
Turning now to banking news, shares of Cincinnati-based Fifth Third Bancorp are dodging the downturn on the markets with a little help from brother banker R.W. Baird. Following last week's earnings "beat" ($0.49 per share reported for the second quarter, which was $0.06 better than expected), Baird upgraded Fifth Third shares to outperform and assigned the stock a $23 price target.
Not everyone is so optimistic. After all, while it admittedly "beat" earnings, Fifth Third reported a 26% drop in second-quarter profit last week. As good news goes, that wasn't exactly all we'd hoped to see. That most analysts who follow Fifth Third expect the company to post sub-1% earnings growth over the next five years isn't particularly encouraging, either.
That being said, the stock sells for a seemingly cheap 10.7 times earnings valuation, which is about 24% cheaper than its peer regional Midwest banks. Its shares also sell for just 1.5 times tangible book value, which is also pretty attractive. And Fifth Third's 1.2% return on assets and 10.6% return on equity, while not stellar, are both respectable figures.
All things considered, while it's hardly my favorite stock in the banking sector, I can't say that Baird is totally off base in recommending the stock on its potential to bounce back from the second quarter's disappointing results.
Do you have something in an XL?
Our other big banking upgrade of the day is an order of magnitude bigger than regional Fifth Third -- international megabanker JPMorgan Chase. Yet just like Fifth Third, JPMorgan reported a sizable earnings beat last week -- topping expectations by $0.26 with a $1.59 per-share profit in the second quarter.
This morning, JPMorgan received its reward when FBR Capital upgraded the stock (also to outperform) and assigned a $70 price target. Quoted on StreetInsider.com, FBR argued that "investor expectations have been reset and JPM shares should benefit over the next year as the economy and the prospects for positive catalysts improve." Indeed, analysts who follow JPMorgan stock still predict that the bank will earn only $5.48 per share. But FBR thinks $5.77 is achievable.
If FBR is right, then JPMorgan shares that today sell for 14.4 times trailing earnings could soon cost barely 10 times. Between the stock's long-term projected earnings growth rate of 4.5% and its 2.8% dividend yield, this suggests that JPMorgan shares are almost cheap enough to buy.
Of course, there are caveats to that argument. For example, at 0.65% and 7.4%, respectively, JPMorgan's return on assets and return on equity are both inferior to the numbers at much smaller Fifth Third. They're mere fractions of the numbers being posted by top-quality operator Wells Fargo (WFC 2.29%), which earns 1.5% on its assets and 13.5% on its equity.
But even so, at just 1.4 times tangible book value, JPMorgan Chase is in at least one respect even cheaper than smaller Fifth Third. Plus, it pays a bigger dividend, is expected to grow earnings faster, and offers a more diversified, presumably more stable, investment.
Again, this is not my favorite banking stock. But if you agree with Baird that Fifth Third is a stock worth looking at for investment, you'll probably agree with FBR that JPMorgan Chase is an even better opportunity.
