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 Brinker (EAT), but downgrades for both Nike (NKE) and Discover Financial (DFS). Let's start out the first day of winter on a bright note, and get right to the...
Good news first
Friday is looking like a good day for shareholders of Chili's restaurant chain-owner Brinker International, which scored an upgrade to "buy" from analysts at Sterne Agee this morning. The best part? Brinker probably deserves it.
Selling for just 16.1 times earnings in an industry where the average P/E ratio is closer to 20, the stock looks cheap right from the get-go. Brinker's P/E is also almost precisely equal to the combination of its projected growth rate (13.5%) and its dividend yield (2.5%), creating a total return ratio almost precisely equal to what most value investors would call a "fair price" (i.e., 1.0). Best of all, Brinker is a superb cash-earner, generating positive free cash flow of $171 million over the past 12 months, or about 10% better than the $155.5 million the company reported as its net income for the period.
With a valuation that's arguably anywhere from fair to cheap -- and almost certainly not expensive -- Brinker looks good for a 10% gain, or even more, in the year ahead.
No good deed...
Now let's check out the bad news. Yesterday, Nike stunned the skeptics with a fiscal second-quarter earnings report showing 7% revenue growth and an earnings beat. (Even though earnings were down year over year, they still exceeded estimates.) Nonetheless, analysts at Janney Montgomery Scott downgraded the shares to neutral. Why?
Well, there are a couple of reasons that Janney looked askance at Nike -- and a couple more reasons that you should, too. For example, as reported on StreetInsider.com, inventories at the sportswear specialist rose 9%, so unsold goods accumulated at a faster rate than sales grew. Future orders (up 6%) rose less than expected (7%).And gross margins were down 30 basis points.
Today, at a valuation of 21.5 times earnings and paying a meager dividend yield of less than 1%, Nike shares continue to sell at a steep premium to the 8% long-term earnings growth that Wall Street expects to see out of the stock. Result: Janney's move to "neutral" actually looks pretty generous, and is probably still a better rating than this stock deserves.
Discover a bargain?
Last but not least: Discover Financial. The credit card purveyor reported $1.07 per share in fourth-quarter earnings yesterday, about $0.03 shy of consensus expectations -- this, despite collecting more revenue than expected. Discover tried to soften the blow by announcing a dividend hike to $0.56 a share annually -- up 40%. That didn't prevent FBR Capital from downgrading the stock this morning, though (to "market perform").
FBR worries that "initiatives designed to drive receivables and transaction growth will result in elevated operating costs in 2013," potentially hurting profits. And yet, when you look at the stock price, it almost looks like that worry has already been priced into the shares.
Discover currently costs less than nine times earnings, despite consensus expectations calling for nearly 11% annual earnings growth over the next five years. Add in a dividend yield that now tops 1.4%, and it's hard to argue Discover is anything but cheap -- downgrade notwithstanding.