Friday's Top Upgrades (and Downgrades)

Motley Fool

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 top trio of newsmakers includes an odd couple of new buy ratings: medical equipment maker Medtronic (MDT) and the decidedly unhealthy Krispy Kreme Doughnuts (KKD). Meanwhile, health-care player WellPoint (WLP) gets a downgrade.

All's not well at WellPoint
Let's tackle that last one, first. As StreetInsider.com confirms this morning, Morgan Stanley has just pulled its endorsement on WellPoint. Citing poor "execution," the analyst downgraded the shares to "equal weight" this morning. But do the numbers back up this assessment?

Not really. Sure, as The Wall Street Journal recently pointed out, WellPoint is suffering from "erosion in the ... company's membership ranks," "pricing pressures," and even a potential change of control at the White House.

All that has to be weighed in determining WellPoint's prospects, but even factoring it all in, Wall Street as a whole still sees WellPoint growing its earnings at nearly 10% per year, on average, over the next five years. For a stock that costs less than eight times earnings today, that's awfully cheap, the more so when you consider that WellPoint pays its shareholders a 2% dividend as they wait for it to turn its operations around. Morgan Stanley may be sick of waiting, but long-term-focused investors should have more patience.

Medtronic: The patient will live
In happier news, Medtronic shareholders got a shot in the arm this morning, as analysts at Argus Research upgraded their stock to "buy." That's big news, made all the bigger by the size of the swing in Argus' opinion. As recently as yesterday, the analyst was still telling investors to sell the stock.

Why the change of heart? No mystery there: Medtronic is due to report earnings on Tuesday, and expectations are low. Long term, Wall Street only expects to see mid-single-digit earnings growth at Medtronic, with next week's earnings believed to be up just 7.5% over last year's Q2. Consequently, any good news -- or even guidance promising good news in the near future -- could send the shares soaring. At 12 times earnings, and with free cash flow running about 10% ahead of reported net income (indicating strong quality of earnings), the risk of an earnings beat is real. Argus is right to be cautious.

Relax. Have a doughnut.
If you're nervous about Medtronic's upcoming results, analysts at Wedbush have a few words of advice for you: Relax. Sit back, and enjoy a nice doughnut ... or at least a few shares of Krispy Kreme.

Wedbush says the news should be good when Krispy Kreme reports earnings next week: "acceleration in domestic company and franchise unit development, driven by improved cash-on-cash returns combined with already industry-leading international growth, could result in sustained high-teens to low-20% EPS growth and an expanded valuation."

Actually, with shares currently selling for just three times trailing earnings, it's hard to see how the valuation could do anything but expand. Sure, in a year or two, Wall Street sees profits falling back to a level that would value Krispy Kreme at a multiple in the 20s. But even so, the long-term prognosis for Krispy Kreme -- 35% growth, compounded annually over the next five years -- looks much healthier than the doughnuts.

Most investors should probably buy the shares instead of the doughnuts.

Fool contributor Rich Smith holds no position in any company mentioned. The Motley Fool owns shares of WellPoint. Motley Fool newsletter services have recommended buying shares of WellPoint.

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