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 AMC Networks Inc (NASDAQ:AMCX) and a higher price target for Activision Blizzard, Inc. (NASDAQ:ATVI). But it’s not all good news, so let’s start off with a quick look at why one analyst is…
The big, bad news of the morning is that analysts at Compass Point have just issued a sell recommendation on Charles Schwab Corp (NYSE:SCHW) . Previously only neutral on the stock, Compass now sees a real possibility that Chuck’s shares will fall to $15, and recommends dumping the stock before it gets there. But could it be that Compass Point is steering you wrong?
I think so, and here’s why: According to Compass, its downgrade today was “primarily driven by valuation, as shares now trade at 20x our 2014 EPS estimate.” The analyst sees small investor trading as rather “lackluster,” and believes interest rates are unlikely to rise significantly in the short term, removing that potential catalyst for Schwab profits as well.
Be that as it may, I’m not sure there’s a strong case for actually selling Schwab at today’s prices. Although the stock looks pricey from a trailing P/E perspective, its price-to-free cash flow ratio is still less than 21 and its forward P/E ratio also looks attractive relative to projected 18% annual profits growth. Throw in a modest 1.3% dividend yield and, while I don’t think the stock is as cheap as it recently was, it’s still not so grossly overvalued as to require you to rush right out and sell it.
Mad about AMC Networks Inc
The story at AMC Networks Inc (NASDAQ:AMCX) looks even better, and kudos are due to the analysts at Maxim Group for pointing this out today. Maxim, you see, wrapped up the trading week with an upgrade to buy for the network behind such hits as “Mad Men” and “The Walking Dead.”
At first, this might seem like a strange call, what with AMC Networks Inc (NASDAQ:AMCX) costing “32 times earnings” and all. But here’s the thing: AMC generates a whole lot more cash from its business than its GAAP “earnings” let on. If the company got to report $136 million in such earnings last year, its actual free cash flow for the same period was $550 million — four times more!
Result: AMC costs only eight times annual free cash flow today. On a growth rate that most analysts agree could exceed 20% annually over the next five years, that’s insanely cheap. Fact is, AMC Networks Inc (NASDAQ:AMCX) would be a bargain at even half its projected growth rate, and Maxim is right to recommend it.
A blizzard of cash
And speaking of companies with great cash flow, Activision Blizzard, Inc. (NASDAQ:ATVI) is practically buried under the stuff. The video gaming company sports a balance sheet rich with $4.4 billion in cash and not a lick of debt. It’s got more cash pouring through the door, too, as each year brings new free cash flow of nearly $1.3 billion. And to top it all off, the company’s sitting on the cusp of the next refresh in video gaming consoles, as Nintendo, Sony Corporation (ADR) (NYSE:SNE), and Microsoft Corporation (NASDAQ:MSFT) square off to sell consumers on their next-gen devices.
Recognizing all this, analysts at Stifel Nicolaus this morning upped their price target on the buy-rated stock to $17 — and they’re right to do so.
Priced at 12.5 times earnings today (or at an enterprise value-to-free cash flow ratio of just 9.5), and paying a 1.3% dividend, the company looks only fairly priced for the 8% Wall Street expects it to produce. Personally, however, I think that 8% rate might be just a wee bit conservative. (Hint: The average stock in the gaming industry is pegged for 19.3% growth, and Activision is the biggest dog in the pound). If I’m right — if Stifel is right — this means Activision’s going to grow a whole lot faster than Wall Street currently gives it credit for, and is a whole lot cheaper than it looks.
Fool contributor Rich Smith owns shares of Activision Blizzard. The Motley Fool recommends Activision Blizzard and Nintendo. It also owns shares of Activision Blizzard and Microsoft.
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