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 we feature a trio of new ratings -- gold stars for Internet stars Yelp (YELP) and LinkedIn (LNKD) , but on the down side...

Middleby gets a lump of coal for Christmas
Commercial oven maker Middleby (MIDD) shares are taking a pounding Friday, down more than 3% -- and for this, you can thank the bankers at BWS Financial.

BWS initiated coverage of Middleby this morning, you see, assigning the stock a "sell" rating, and slapping a $160 price target on the stock -- which had been selling for north of $220. That's a curious reaction to a stock which just last week reported third-quarter earnings that beat analyst estimates by a good $0.21, crushing revenue expectations in the process. But according to BWS, the sell rating is deserved.

BWS warns that the trend toward more and more "quick serve" restaurants opening "is now coming to an end." And as it ends, so too will Middleby's high-growth phase. Going forward, BWS predicts we will see less than 10% organic growth at Middleby, a new trend exacerbated by stiffer competition from the company's rivals, which BWS says have "introduced energy efficiency and customer productivity centered equipment into their product lines."

If BWS is right about that -- if it's right about the growth rate in particular -- this could indeed prove troubling for Middleby shareholders. After all, this high-flying stock, up 77% over the past year, now sells for a P/E ratio of more than 28. And with cash profits now trailing reported GAAP net income badly, Middleby's price-to-free cash flow ratio is approaching nosebleed levels -- more than 38 times FCF.

Granted, most analysts out there think BWS is being too pessimistic about Middleby. The consensus on Wall Street is that Middleby will grow earnings over the next five years at not 10%, but 21% . To be perfectly honest, though, even if they're right, and BWS is wrong, I think 38 times earnings is too much to pay for 21% growth. Anyway you cut it, Middleby stock looks overheated, and needs to cool off a bit before it becomes buyable again.

Help for Yelp?
Turning now to the stocks that Wall Street actually likes , we begin with online consumer review service Yelp -- which just scored an endorsement from Wall Street when ace analyst Stifel Nicolaus assumed coverage with a buy rating and an $85 price target.

Unfortunately, this is a recommendation I simply cannot get behind.

Unprofitable on a trailing-12-month basis, and priced at more than 360 times its projected profits for next year, Yelp shares look vastly overpriced -- even if Wall Street is right about the stock being able to grow earnings at 40% per year.

The fact is, however, that with no positive GAAP earnings number to grow yet, it's hard to put a lot of confidence in that supposed growth rate. And even if you apply the growth rate to Yelp's barely positive free cash flow number instead, the company only generated $0.1 million in positive FCF over the past year. That gives Yelp a P/FCF ratio of... drumroll, please... 45,900.

Sure, when looked at under other metrics, Yelp's valuation isn't totally out of whack with its Internet peers. It sells for only a slightly higher price-to-sales ratio than Facebook for example, and is actually only half as expensive as Twitter on a P/S basis. Still, when evaluated on its own merits, I can't call Yelp shares anything but vastly overvalued... and doomed to fall.

Is LinkedIn the weakest link?
Speaking of overpriced stocks, Stifel Nicolaus appears to have a fondness for them. Because in addition to recommending Yelp today, the analyst also recommended buying LinkedIn.

Now, on one hand, this last recommendation makes a bit more sense to me than Stifel's endorsement of Yelp. LinkedIn, after all, sells for a slightly lower P/S ratio than Yelp. LinkedIn is also profitable already, whereas Yelp is not. And LinkedIn generates a heaping helping of real free cash flow from its business -- about $170 million a year, or five times reported GAAP earnings.

Problem is, this still leaves the stock trading for more than 160 times cash profits (and more than 1,000 times GAAP earnings). So while I certainly understand investors', and analysts', attraction to a stock that's expected to grow earnings at 54% annually over the next five years, that growth comes at a very high price indeed. That's why I think that Stifel's recommendation to buy LinkedIn is an invitation you should "ignore."

Fool contributor Rich Smith has no position in any stocks mentioned, and he doesn't always (read:often) agree with his fellow Fools. The Motley Fool recommends and owns shares of LinkedIn and Middleby.

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