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 an upgrade for Gap (GPS) and a higher price target for Domino's Pizza (DPZ), but for Caribou Coffee (CBOU), it's downgrade time. So perk up your ears, and let's give the analysts a listen...
No buzz for Caribou
On Dec. 17, Caribou Coffee shares popped in response to a buyout offer from The Benckiser Group, which wants to pay $16 a share for the company -- $340 million in all. Problem is, Caribou shares currently sell for $16.17, which suggests the price will fall unless a competing offer appears. What are the chances of that happening?
This morning, analysts at Dougherty & Co. voted with their feet, downgrading Caribou shares to neutral and setting a price target right where Benckiser is bidding: $16. They're right to do so.
Not only have we seen 10 days go by with nary a sign of a competing offer; right now, Caribou shares cost a whopping 32 times earnings, which suggests the shares are overvalued in light of 23% long-term analyst growth expectations for the stock. In short, investors paying more than $16 today need two things to go right in order to avoid losing money: First, a competing buyer must appear. Second, the Benckiser buyout itself must proceed -- else, absent that buyer, the overvalued shares must fall in price. That makes for two ways to lose money on this stock, and only one way to make any. In such a situation, a downgrade seems prudent.
Don't mind the Gap
In happier news, we learned today that independent equity house Standpoint Research has removed its sell rating from Gap, and upgraded the shares to hold. Playing the odds of a reversion to the mean, Standpoint notes that Gap shares are down 15% in a flat stock market -- meaning the short has "worked" and should now be closed. According to StreetInsider.com, Standpoint's not yet ready to endorse Gap as a buy... but could do that if the stock falls further in 2013.
I agree. Valued at nearly 15 times trailing earnings today (or even at the 10.6 times free cash flow its shares fetch), Gap appears overvalued based on the consensus belief that it will only achieve annual earnings growth of about 9% over the next five years. The stock's slightly expensive, but no longer a screaming short. By the same token, it's not nearly cheap enough to offer a margin of safety to buyers.
Domino's gets tastier
Last but not least, we come to Domino's Pizza, buy-rated, and recipient of a hike in price target to $50 today from Oppenheimer. But it seems to me that Oppy should be taking a cue from Standpoint and getting more cautious, not less, on this one.
Pegged for 13% long-term earnings growth, Domino's has a bit more zip to it than Gap does. Still, Domino's isn't a fast-enough grower to justify its 24-times-earnings price tag. Adding to the menu of items to worry about, Domino's carries a heavy debt load -- about $1.5 billion net of cash on hand.
Long story short: Even superior free cash flow can't save this stock. Domino's is overvalued, plain and simple. And Oppenheimer is wrong to urge investors to pay extra for this pricey pie.
Fool contributor Rich Smith has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above.
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