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've got new upgrades on tap for Aeropostale (ARO) and True Religion (TRLG). On the other hand...
Qualcomm just got disqualified
Let's tackle the bad news first. This morning, investment banker D.A. Davidson pulled its "buy" recommendation for Qualcomm (QCOM), and downgraded the chip specialist to "neutral."
While praising the company as "dominant" in mobile, and even admitting Qualcomm "will probably add market share points with the ramp of the LTE iPhone and the ramp of Snapdragon solutions in various smartphones" in the fourth quarter, Davidson warns that "competition is ramping." And not just from its main chip-making rivals, either. Davidson warns that there's also a "trend toward in-house design" afoot, as smartphone manufacturers try to build their own, tailored semiconductor chips, rather than buying from big suppliers.
All of this threatens Qualcomm's ability to hit the 15% long-term growth rate that Wall Street is expecting of it. And seeing as Qualcomm's now trading for a P/E ratio above this rate -- 17.6 --and arguably expensive already, any deceleration in the growth rate would make the stock look only more overpriced.
Aeropostale could fly
Looking to dodge the Qualcomm bullet and invest in an area a bit less subject to upset than the world of high-tech? Standpoint Research suggests you look no further than retail, and clothier Aeropostale in particular. "Aeropostale shares have been washed out," says the analyst, "now down by more than 3,000 bps versus the S&P since our February downgrade." As a result, "bad news is already more than priced in [and] we are betting on a reversion to the mean and that this represents a bottom."
Could Standpoint be right? Like Qualcomm, Aeropostale sells for a premium P/E ratio north of 17, but Aero's growth rate isn't even as robust as what Wall Street expects Qualcomm to produce. On average, analysts think the best Aeropostale can manage is about 12% long-term earnings growth over the next five years.
The good news here is that unlike Qualcomm, Aeropostale is generating a whole lot more free cash flow than its GAAP numbers suggest. Over the past year, free cash flow at the firm amounted to $95 million, or half-again what Aeropostale claimed as "net income." At an enterprise value of less than 10, and with 12% growth in the offing, Standpoint does indeed appear to have spotted a bargain.
Regaining faith in True Religion
An even better bargain, though, may be the stock that KeyBanc Capital Markets just upgraded: True Religion.
Albeit only upgraded to "hold," True Religion at 14 times earnings and 15% growth both costs less and is growing faster than Aeropostale. Plus, the company just announced it is for sale, and received an immediate bump in share price (21% and counting) in response.
KeyBanc points out that the company has the added benefit of holding about $7.95 a share in cash, which means that as cheap as True Religion looks on the surface, it's actually even cheaper than it appears. Toss in TR's monster 3.7% annual dividend, and investors unsure whether the buy-rated Aeropostale or the hold-rated True Religion is the better bargain can count on being paid for their patience as they wait for Mr. Market to decide which analyst was right.