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 include a downgrade for Apache (APA), balanced by an upgrade for Abercrombie & Fitch (ANF), and a higher price target for eBay (EBAY).
Bad news first
Let's tackle Apache first: This morning, analysts at both Deutsche Bank and RW Baird downgraded the oil company to various flavors of "neutral." Deutsche said "operating trends [are] moving in the wrong direction," and warned, "We do not expect a meaningful improvement in 4Q12 operating trends and see some downside to street expectations surrounding 2013." The analyst cut $20 off its price target, predicting Apache shares will fetch only $90 a year from now.
Baird wasn't quite as harsh, setting a more aggressive $102 price target on the shares. The strange thing here, though, is that whether you believe Deutsche ($90) or Baird ($102), either way, both analysts are saying Apache shares are significantly undervalued at today's share price of less than $75. So why aren't they urging investors to buy it?
Here's why: Right now, analysts only expect Apache to post modest, 5.5% long-term growth in profits. That means that even though the shares cost "only" 12 times earnings, they're arguably overpriced for the stock's limited growth prospects. Add in Deutsche's worries that Street earnings estimates have "downside" risk to them -- that the company may not even achieve 5.5% growth -- and the case against Apache grows even stronger. Caveat investor.
"Bear"-ed turns bullish
Our second top rating today comes from one of these same analysts, as Baird, bearish on Apache, takes a more bullish view of Abercrombie & Fitch. This morning, Baird upped its price target on A&F to $55, and raised its rating to "outperform." But does the stock deserve it?
I'm not so sure it does. Right off the bat, at 37 times GAAP earnings, A&F seems awfully pricey, even if the stock achieves the 17% long-term growth target Wall Street has set for it. True, the company generates more free cash flow than its GAAP earnings reflect -- about $156 million over the past 12 months. But even if you value the company on its free cash flow, and even if you give A&F credit for the $245 million in net cash on its balance sheet, the enterprise value-to-free cash flow ratio on this one still works out to an optimistic 22 times ratio.
Result: It's still too expensive for 17% growth. Unless A&F meets, and exceeds, that already aggressive goal, the stock's likely to underperform the stock market -- not outperform it, as Baird predicts.
eBay: Buy it now?
Believe it or not, though, there are even worse picks on Wall Street than Apache or A&F. Take, for example, our final featured analyst pick of the day: eBay. This morning, analysts at Argus Research doubled down on their buy recommendation on the Internet auctioneer, raising their price target 12% to $65 a share.
Don't believe it.
Priced at 17.6 times earnings, eBay is on-its-face expensive based on consensus earnings growth estimates of 14.3%, long-term. And in fact, the stock's even more expensive than it looks. Free cash flow at eBay, you see, is a mere $2.2 billion -- which sounds like a lot, but in fact means that for every $1 that eBay claims to be earning under GAAP, it's actually generating only $0.57 in real free cash flow.
Put another way, this stock that looks expensive at 17.6 times earnings is actually frightfully overpriced at more than 30 times annual cash profits -- again, on growth estimates less than half that number.
Long story short, I'd much rather be short this stock than long.
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