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 a pair of upgrades for AT&T Inc. (NYSE:T) and IMAX Corporation (USA) (NYSE:IMAX). But the news isn’t all good, so before we get to those, let’s find out first why…
Liquidity Services, Inc. (NASDAQ:LQDT) is drying up
Shares of surplus, scrap, and salvage merchandise liquidator Liquidity Services, Inc. (NASDAQ:LQDT) are getting vaporized Monday, down nearly 4% as of this writing. For this, you can (at least partly) blame analysts at the Benchmark Company, who cut their price target on Liquidity to $47.
Now granted, $47 is still a pretty optimistic target for Liquidity investors to shoot for. The stock today trades under $34, so a move to $47 would still produce about a 38% profit — not quite as good as the 40%-plus profit Benchmark used to predict, but still an attractive prospect.
Problem is, it’s hard to see how Liquidity gets there. Even after today’s sell-off, the shares still cost nearly 28 times earnings — pricey for a company expected to grow its profits at about 18% per year over the next five years. It’s also worth pointing out that the profits Liquidity’s earning today aren’t of particularly high quality. If Liquidity reported “earning” $40 million last year, its actual cash flows from operations were only $24 million, and, once you subtract capex, actual free cash flow at the firm was less than $17 million.
This all works out to a price-to-free cash flow ratio of 64 times on the stock — far too much for an 18% grower, to my mind. And this suggests that today’s sell-off of 4% could be only the start of a much steeper slide.
AT&T Inc. (NYSE:T): Time to phone home?
Of course, if it’s free cash flow you like, our first upgrade of the day has it in abundance. AT&T Inc. (NYSE:T) generated some $19.8 billion in cold, hard cash profits last year — more than twice its reported $7.4 billion in “net income” under GAAP.
AT&T Inc. (NYSE:T) stock just scored an upgrade to “buy” from analysts at Argus, and over at Canaccord Genuity, they’re talking of improved revenues arising from “strong customer growth in Q2/13.” True, Canaccord also says that earnings could take a tumble due to “promotions and incremental investments.” But even so, the company’s less-than-10-times free cash flow valuation looks attractive in light of the stock’s 6.3% projected growth rate and 5.1% dividend yield.
Fact is, were it not for the fact that AT&T Inc. (NYSE:T)’s carrying more than $70 billion in debt, I might be tempted to take Argus’ advice, and buy some myself. (But since it is carrying all that debt, I think I’ll pass.)
A brighter picture at IMAX Corporation (USA) (NYSE:IMAX)
Finally, we come to IMAX. 3-D movie-viewing has gone definitively mainstream in America, and around the globe. Now, analysts at B. Riley are saying it’s time to capitalize on this fact and add IMAX Corporation (USA) (NYSE:IMAX) to your portfolio. With the stock trading ahead of Riley’s old $24 price target already, the analyst now sees it rising as high as $37 a share over the course of the coming year — a potential 35% profit.
And yet, I just can’t see myself buying this one either. Why not?
Well, consider: Right on the surface, IMAX Corporation (USA) (NYSE:IMAX) shares look pricey at a P/E ratio of 45. They look even pricier when you dig into the details and find that IMAX Corporation (USA) (NYSE:IMAX) generated only $28.3 million in real free cash flow last year — barely two-thirds of its reported “profit” of $41.7 million.
The resulting price-to-free cash flow ratio of nearly 65 is even more expensive than what we see at Liquidity Services. So even at a monster projected growth rate of nearly 33% annually over the next five years, IMAX Corporation (USA) (NYSE:IMAX) shares look quite risky. One hiccup in growth, one excuse to permit analysts to begin ratcheting their growth projections back to more realistic levels, and this stock could fall hard.
For now, the momentum is clearly on IMAX’s side. It’s the future I worry about.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends IMAX and Liquidity Services. The Motley Fool owns shares of IMAX.
The article Monday’s Top Upgrades (and Downgrades) originally appeared on Fool.com and is written by Rich Smith.
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