This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, with earnings season in full swing, Wall Street's busy tweaking its target prices based on the latest data -- upping bets on Urban Outfitters (URBN) and Constellation Brands (STZ), while at the same time...
Taking the shine off Tiffany
Tiffany (TIF) reported holiday sales "at the low-end of our expectations" this morning, saying November-December sales rose only about 4% worldwide. Management is guiding investors to expect full-year profits also toward the low end of the company's previously predicted $3.20- to $3.40-per-share range. That will be down from last year, and almost certainly below the number analysts are looking for. (The consensus is currently $3.31 per share.)
Investors are not amused, whacking the shares 4% in Thursday trading. One analyst isn't too happy, either, as Canaccord Genuity announces it's shaving $7 off its target price for Tiffany, cutting it to $58 ... and that's the good news.
The bad news is that Tiffany isn't worth anywhere near even the $58 target price Canaccord now touts. Priced at nearly 19 times earnings today, and pegged for 11.5% long-term profits growth before today's update, the stock already looked pretty expensive. But if you examine Tiffany's cash flow statement and notice that Tiffany currently generates a meager $0.18 in real cash profits for every $1 it reports as net income, it's clear this company is overpriced.
Result: Cuts to target are only the beginning. Sooner or later, this stock is getting downgraded.
Speaking of stocks that cost too much, shares of Urban Outfitters are up 66% over the past year, and Canaccord sees this one going all the way to $45 before another year is out. It's wrong about that, though. Urban Outfitters is at least as overvalued as Tiffany, and I'll tell you why.
On one hand, Urban's in a bit better situation than Tiffany, inasmuch as it's generating a bit more cash -- $0.85 for every $1 it claims as net income. On the other hand, though, the stock's so much more obviously overvalued on a P/E basis as to render this (slightly) better free cash flow irrelevant to the ultimate conclusion.
Simply put: 32 times earnings is too much to pay for a company that most analysts think will grow at 17% per year over the next five years (and that just put its holiday sales growth at 15%). It's about twice as much as a value investor should pay for a stock. As a result, I see Urban falling into decay as well.
Stars shine on Constellation Brands
What's the solution? How about checking out a stock that actually generates more cash than it claims as net income on its income statement, rather than less? How about checking out Constellation Brands?
That's what ace investor Stifel Nicolaus did this morning, and upon taking a closer look it decided to bump up its target price on the stock to $45.
Why? Perhaps because, at 16 times earnings, this wine and beer merchant costs less than either Tiffany or Urban Outfitters, and so has a bit more room to keep growing its stock prices. Constellation also generates outsize free cash flow -- $466 million over the past 12 months -- that exceeds reported net income by 14%. That's enough to give the stock a price-to-free cash flow ratio of 14.
Now personally, I don't think even this number is low enough to justify a buy at Constellation's modest 10% growth rate, although that's the rating Stifel assigns the stock. Still, 14 times free cash flow is a lot cheaper than the valuations at Tiffany and Urban Outfitters. If it's the lesser of three evils you're looking for, I think this is the least dangerous call Wall Street is making today.
Rich Smith has no position in any stocks mentioned. The Motley Fool owns shares of Tiffany.