Tuesday'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, our headlines include new buy ratings for MAKO Surgical (MAKO) and Lions Gate Entertainment (LGF). Meanwhile, Lufkin Industries (LUFK) gets a cut.

An improved prognosis for MAKO
Let's start the news on a bright note, with Mizuho Securities' just-announced upgrade of MAKO Surgical. Last week, MAKO won a court-ordered injunction against rival Blue Belt Technologies, forbidding Blue Belt from hiring a former MAKO sales manager, and ordering it to destroy all proprietary MAKO business information in its possession. Today, this news translated into an upgrade to "buy" for MAKO at Mizuho and a new $14 price target on the stock.

With MAKO shares currently costing only $11, this raises the prospect of a 27% profit for investors today. Problem is... it won't happen.

Winning enforcement of a non-competition agreement against a former employee is all well and good, of course. But it doesn't change the fact that MAKO remains a deeply unprofitable operation, or that it continues to burn cash at an even faster rate than it reports GAAP losses. Valued at 4.8 times sales (because it has no profits to value it by), MAKO remains a speculative stock only. Until it figures out a way to earn real profits from its business, it's hard to call the stock an "investment"... or a "buy."

Analysts upgrade. Lions Gate investors purr
A better buy idea may be found in the stock Argus Research initiated coverage of today: Lions Gate Entertainment. Sure, on the surface, the $0.34 a share that Lions Gate earned last year doesn't look like all that much more than the profits MAKO failed to generate. But most analysts agree that Lions Gate is in the hunt for bigger profits in years to come.

On average, Wall Street estimates see Lions Gate growing its per-share earnings by 22% per year over the next five years. That may not sound like a lot relative to the stock's 70 "P/E" ratio. But if we assume the company will grow its real cash profits at a similar rate, then the $214 million in free cash flow that Lions Gate generated last year gives the stock a price-to-free cash flow ratio of only 15. That's plenty cheap enough for 22% growth. It's probably cheap enough to justify Argus' "buy" rating on the stock as well.

My one word of advice here would be to keep an eye on debt. Lions Gate's debt load currently exceeds its cash reserves by roughly $1.3 billion. I see the stock as fairly priced even factoring this debt into the equation -- if the growth rate holds up. If Lions Gate stumbles on growth, however, or fails to keep debt levels in check, well, either one of those developments could prove a thorn in the paw of Lions Gate investors.

Lufkin's leap is over
Finally, and filed in the in memoriam category of today's column, we turn to Lufkin Industries. As you've probably heard by now, General Electric (GE) announced yesterday that it has agreed to buy Lufkin for $88.50 per share in furtherance of its move into the energy industry.

Investors may quibble with the stock price, and the 36-plus times earnings ratio that GE is shelling out for its new acquisition. Indeed, whether you value the deal on price-to-sales, price-to-book, or price-to-earnings, GE is paying a pretty penny. The one thing that no one can dispute, though, is that Lufkin shareholders have made out like bandits on this deal, scoring a 38% one-day profit thanks to GE's largesse.

Tempting a target as Lufkin may be, however, what with its projected 24% annual earnings growth rate and all, it's hard to see a bidding war breaking out here at these high prices. It's hard to see a rival bidder emerging, and failing that, it's hard to see how Lufkin shares could have any more room to run after this week's price spike. Accordingly, Howard Weil this morning removed its "outperform" rating from the stock and downgraded Lufkin to "sector perform."

Me, I'll go a step further than that. I'll say that with the stock trading within just two bits of GE's proposed purchase price, it's time to take your winnings, declare victory, and sell Lufkin.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends MAKO Surgical. The Motley Fool owns shares of General Electric Company.

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