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're looking at a new upgrade for Adobe Systems (ADBE), and two more for homebuilders Ryland (RYL) and PulteGroup (PHM), while Clean Harbors (CLH) gets downgraded to neutral. Let's dive right in, tackling the...
Bad news first
With the Dow down in early trading, Thursday's looking pretty droopy for most investors, but it's especially bad news for shareholders of hazmat disposal specialist Clean Harbors. Citing concerns about the stock's "valuation," and falling rig counts and equipment utilization among its oil drilling clients, RW Baird cut its rating on Clean Harbors to "neutral" this morning, and slashed $10 off its target price, bringing it down to $58 a share... and they're right to do so.
Priced at 20 times earnings, and paying no dividend, Clean Harbors' valuation would look stretched even if the stock was growing better than its anticipated 14% annual growth rate. In fact, though, Clean Harbors shares are more expensive than they look. Free cash flow at the firm has been running about 13% behind reported net income over the past year. So whether or not Baird is right about growth coming in lower than expected in coming quarters, the stock's already overpriced today.
Chances are, Baird is actually being overgenerous in downgrading Clean Harbors only to "neutral." Chances are, you're better off just going ahead and selling the shares.
Adobe Systems: Rock solid?
In happier news, a report of 7% sales growth and $0.58 per share in profits (a penny short of consensus) sent Adobe shares down a bit yesterday ... but they popped right back up, to close the day higher. This morning, they're climbing higher still on the back of an upgrade to "outperform" from analysts at RBC Capital Markets.
But here's the thing: Investors were right when they sold off Adobe yesterday, and wrong when they bought it back. Consider: At more than 13 times annual free cash flow -- and again, no dividend -- Adobe sells for a pretty premium to its projected growth rate, which barely tops 10%. The stock's even more overvalued when judged on its earnings, which work out to a P/E ratio of 21.
Investors may have been encouraged by Adobe's announcement of strong customer adoption of its new Creative Cloud product. But so far, more paying customers still isn't translating into enough profits to justify the stock's high price.
And speaking of high-priced stocks ...
Two other companies getting positive nods from Wall Street this morning are Ryland and Pulte, both of which received upgrades to "buy" from analysts at Compass Point. According to StreetInsider.com, Compass justifies its endorsement of Ryland by pointing to the stock's selling for "a lower valuation than its peers," and arguing the stock is worth 20 times the earnings it's expected to make next year. Pulte, in contrast, should sell for a lower 14 times 2013 earnings (again, this is according to Compass) based on the company's higher risk of "mortgage repurchase exposure."
But here's the thing: Based on consensus earnings projections, Pulte already costs 18 times what it's expected to earn next year -- which seems to be more than what Compass says the stock is worth. Meanwhile, Ryland sells for a 19 times forward P/E multiple -- suggesting only about a 5% profit potential for buyers today, if the stock goes to 20 times forward earnings tomorrow.
Mind you, I personally don't think that this pair of stocks, each expected to show only 5% profits growth annually over the next five years, is worth anywhere near 14 times (or 20 times) earnings. I think both stocks are vastly overpriced already. All I'm saying is that if you listen to Compass, its own arguments for buying the two stocks... don't make a whole lot of sense either.
Fool contributor Rich Smith holds no position in any company mentioned. The Motley Fool owns shares of Clean Harbors. Motley Fool newsletter services have recommended buying shares of Adobe Systems. Motley Fool newsletter services have recommended creating a diagonal call position in Adobe Systems.