This Just In: Upgrades and Downgrades

Micron Technology (MU 4.89%) missed earnings last night -- and badly. The stock's off 5% this morning, but the earnings miss is only partly to blame, because ...

Yep, you guessed it: Micron Technology just got downgraded.

The news
Reporting on its fiscal Q1 2016 last night, Micron disappointment investors on both sales and earnings, then followed up with guidance that promised the company's Q2 will feature its first quarterly loss since early 2013.

Q1 earnings came in at $0.24 per share on $3.35 billion in sales. Those sales were within the range management had previously guided investors to expect, but fell below analyst predictions, as did earnings -- and the numbers were down 75% and 25%, respectively, year over year.

The bad news
In response to all of this, it's not terribly surprising to hear that an analyst (Raymond James) has decided to downgrade Micron stock, but ...

The less bad news
What is pretty surprising is how very modestly Raymond James ratcheted back its endorsement of Micron. Previously recommending the stock as a "strong buy," this top-rated analyst actually only downgraded Micron to outperform. What's more, the analyst's new price target of $17 per share (down from $26 previously) still appears to promise investors today as much as a 25% profit from the stock.

But is that realistic?

Let's go to the tape
It's anything but a sure thing, but there's at least some reason to hope for a rebound at Micron. According to our data at Motley Fool CAPS, where we've been monitoring Raymond James' performance since early 2012, this is actually one of the better analysts working on Wall Street today. Overall, across nearly 300 stock picks in three years, Raymond James has gotten the majority of its stock picks right, and is currently outperforming more than 80% of the investors we track.

And Raymond James seems particularly skilled in picking semiconductor stocks, where two out of every three stocks it recommends have proceeded to beat the market handily over the past three years. For example:

Although Raymond James certainly suffered a setback from Micron's disappointing report last night, it seems logical to expect that an analyst who's been right a lot about semiconductors in the past might be right again today. And yet ...

Valuing Micron
With $2.9 billion in reported net income over the past 12 months, but a market capitalization of only $14.6 billion, Micron shares currently look ultra cheap at a valuation of just 5 times earnings. They are, however, not as cheap as they look.

You see, GAAP earnings aren't the be all and end all of valuation. More important is the cash the company produces, and Micron currently isn't producing a whole lot of cash -- only about $1.2 billion over the past year, or less than half reported net income. As a result, the company's "P/E" may be just 5, but its price-to-free-cash-flow ratio is 12.2. And if you factor debt into your calculations (hint: always factor debt into your calculations), Micron stock sells for an even higher enterprise value-to-free cash flow ratio: About 15.4 times.

That would be a fair price to pay if Micron were growing its profits in the mid-teens, of course. Instead, analysts on S&P Capital IQ project profits growth of only 7.5% annually over the next five years.

The upshot for investors
So far, none of this is sounding terribly optimistic for Micron shareholders. To be a buy at 7.5% growth rates, we'd want to see Micron generating about $2.4 billion in annual free cash flow -- a number it's hit only twice in the last five years. Granted, CEO Mark Durcan is telling investors he hopes "to see stronger bit growth and cost reductions commencing in the second half of FY16." But will the turnaround be strong enough, and fast enough, to quickly return Micron to historically high levels of profitability?

I'm not so sure.

Raymond James thinks the recent spate of M&A activity in memory chips has set the stage for a "new, emerging oligopolistic structure in the memory industry" that could greatly improve profit margins at Micron. Given Raymond James' record, I'd like to give the analyst the benefit of the doubt on that. But I have to be honest, folks. Micron shares, down 58% in the past 12 months but up more than twice over the past four years still look pretty pricey to me.

Given my druthers, I'd feel a lot more comfortable owning shares of one of Raymond James' other winners right now. Skyworks Solutions, for example, costs less than 20 times earnings, but is projected to grow at better than 20% over the next five years.

Granted, even Skyworks' free cash flow number isn't as great as I'd like it to be, but it's still a whole lot healthier than Micron's. At this stage in the game, I think I'd be more comfortable owning Skyworks than Micron.