Tuesday's Top Upgrades (and Downgrades)

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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 feature new buy ratings for a couple of financial data publishers -- Moody's (MCO) and McGraw Hill Financial (MHFI) . Meanwhile, on the durable goods side of the equation ....

Cummins gets cut
Before addressing the buy ratings, let's get some bad news out of the way first: Cummins (CMI) . The diesel- and natural gas-powered engine specialist reported earnings this morning -- and the news was not good.

The $1.90 in per-share profit that Cummins says it earned in Q3 was a good $0.21 below analyst estimates. Revenue of $4.3 billion likewise fell short of the mark. Adding insult to injury, Cummins warned investors that the rest of the year will probably turn out similarly poorly, with revenues falling 3% for the year as a whole (as opposed to previous promises of only flat revenues) and operating profit margins earned on these revenues likely falling short of even the low end of previous estimates -- 13% or lower.

Shares are down sharply -- 8.5% at last count -- in response to the news. Not helping matters is the fact that analyst R.W. Baird just cut its rating on Cummins from "outperform" to "neutral." But is that the right call?

Well, let's see here: Last year, Cummins cleared $17.3 billion in revenues. A 3% drop from there suggests full-year fiscal 2013 revenues of $16.8 billion. And yet, Cummins' worst-case predicted 12.5% operating margin on $16.8 billion in revenue would work out to $2.1 billion in operating profit -- more than 8% better than what Cummins earned last year.

Assuming net profit rises similarly, we're therefore probably looking at $1.8 billion in net profit for the year, and less than a 13 P/E ratio on the stock. For the 10% long-term growth rate that Cummins is expected to achieve, and the 1.8% dividend yield it now pays, that seems a fair price to me -- and makes Baird's new "neutral" rating look like the right call.

The financials get praised
Now for the good news. Analysts at FBR Capital have initiated coverage of a whole series of financial and other data providers. We'll focus on just two today: Moody's, which rates bond offerings and other debt, and McGraw Hill Financial, which, having sold off its education unit, is now best known as the company behind Standard & Poor's, S&P Capital IQ, and the S&P Dow Jones stock indices.

Moody's just reported its fiscal Q3 numbers, disappointing many analysts with an earnings miss ($0.75 per share, when $0.82 had been expected). But FBR likes both companies and rates both Moody's and McGraw Hill stocks as outperformers, predicting Moody's will go to $85 a share and McGraw Hill to $81.

The two companies sell for similar valuations -- 21 times earnings for Moody's, based on its most recent numbers, and 20.4 times earnings for McGraw Hill. And yet expectations for their future performance differ markedly.

Moody's is only expected to produce 13% annualized earnings growth. Worse, its earnings report this morning showed management walking back expectations from $3.57 per share for this current year to $3.51. (Analysts had been hoping for $3.59.) FBR likes the company regardless, arguing that Moody's "durable franchise, attractive structural drivers, unique pricing power, high incremental margins, stock buyback capacity, and top-shelf management team" all make the stock cheap despite its high price relative to expected growth.

I disagree. To me, 21 times earnings is simply too high a price to pay for 13% growth, even if the company does tend throw off more cash than it gets to report as GAAP profit. To me, McGraw Hill looks like a better bet at a lower valuation relative to earnings, and with a significantly faster projected growth rate (18%) on those earnings. McGraw Hill also, incidentally, pays a slightly more generous dividend yield (1.6%) than does Moody's (1.4%).

With similar business models, but a significant divergence in the valuations of their stocks, McGraw Hill is simply a better bargain than Moody's.

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