This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. In today's headlines, Marathon Petroleum (MPC) earns a buy rating, while Cisco (CSCO) wins an upgrade to outperform. Home Depot (HD), on the other hand, is getting downgraded today. Let's find out why.
Home Depot reported strong Q3 results yesterday, growing earnings, exceeding earnings estimates by $0.04, and raising guidance for the rest of the year. Management now believes it will end the year with $3.03 in per-share profits, growing revenue by more than 5% over 2011 levels.
Pretty good news, overall. So naturally, upon hearing it, Wall Street stock shop Gabelli promptly... downgraded the stock.
Why? Describing a classic case of "buy the rumor, sell the news," Gabelli argues that "the housing recovery is now mostly priced in the current valuation" at Home Depot. Shorter-term, the analyst projects additional revenue for Home Depot from Superstorm Sandy buying will top out about at the level seen with Hurricane Irene -- so no additional lift is expected there. Gabelli argues there's little upside left in the stock, and I agree. At a price-to-earnings ratio of 23, and with long-term growth posited at 15% or thereabouts, Home Depot is more than fully valued already. While Sandy sales could give the stock an additional lift, it will be fleeting in nature.
In short, if you've owned Home Depot over the past year, and are sitting on a 67% gain from your investment, the time to cash that gain in is now.
Can Marathon run?
And where might you reinvest your winnings? Imperial Capital thinks one place to look is refiner Marathon Petroleum. Problem is, Imperial Capital is wrong.
According to the analyst, Marathon "stands apart from its peers" in the "independent refiners universe." I won't argue with that. But I don't necessarily think it's a reason to buy the stock, either. Priced at nearly 12 times earnings, Marathon is only expected to grow its earnings at about 2% per year over the next five years. That's a slower rate of growth than either of rivals Tesoro (TSO) or Valero (VLO). Moreover, both these competitors generate strong free cash flows from their business, whereas Marathon is currently burning cash.
Given that the company's stock price doesn't offer a compelling discount to the valuations at its rivals -- Valero costs a smidge more than Marathon's 11.8 P/E ratio; Tesoro costs significantly less -- there seems to be little reason to prefer Marathon over its faster-growing, cash-generating rivals.
Cisco stands out
And finally, we get to end our column today on a bright note, with a few words about Cisco Systems. Yesterday, as you may have heard, after close of trading, Cisco reported strong fiscal Q1 2013 earnings -- $0.48 per share in profits, or $0.02 better than expected. Guidance for the current second fiscal quarter matched consensus estimates, and at least one analyst noted the company's "upbeat tone" on future prospects.
The news was good enough to win Cisco an upgrade to "outperform" from analyst Pacific Crest, and an 8% bump in market cap from investors. But that's only the beginning. Priced at less than 11 times earnings, and less than seven times earnings net of the company's cash reserves, Cisco looks every inch the bargain based on long-term growth rates exceeding 7.6%.
Plus, when you remember that Cisco has historically generated much more free cash flow than it's reported as net income ($10.5 billion over the past 12 months, for example, versus reported earnings of just $8.4 billion), it's arguable that this stock is even cheaper than it looks. Pacific Crest is right to recommend it.