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 upgrades for a pair of semiconductor firms, Intel Corporation (NASDAQ:INTC) and ARM Holdings plc (ADR) (NASDAQ:ARMH). But the news isn’t all good.
Attaching a neutral rating to Staples
Early this morning, investment megabanker J.P. Morgan announced it is pulling its overweight rating on Staples, Inc. (NASDAQ:SPLS), and downgrading the shares to neutral on fears of “secular pressures” hurting the office supply retail market. Staples shares currently cost a bit less than $14, and while J.P. thinks they’re actually worth closer to $15, nonetheless, the difference between price and value here doesn’t seem to be big enough to keep the banker interested in buying Staples, Inc. (NASDAQ:SPLS) shares.
But is J.P. overlooking an opportunity?
I think so, yes. Consider: With negative GAAP earnings today, and a fair amount of debt on its books, there’s plenty of reason to be leery of Staples, Inc. (NASDAQ:SPLS) shares today — and I don’t blame J.P. a bit for being nervous. That said, Staples still has the nation’s No. 2 e-commerce website. It’s generating plenty of free cash flow ($963 million over the past year), and its stock costs less than 10 times this FCF number. The company pays a pretty generous dividend yield for a retailer — 3.4% — and is currently being priced like its 4% long-term projected growth rate is a given.
My hunch: If Staples, Inc. (NASDAQ:SPLS) can find a way to grow even a little bit better than that — by stealing share from Office Depot Inc (NYSE:ODP)-Max as they’re busy consummating their merger, perhaps, or by taking advantage of Amazon.com, Inc. (NASDAQ:AMZN)‘s increasing subjection to state sales tax laws to compete more strongly with it on price — Staples shares could turn out to be a steal at today’s prices.
Time to give ARM a hand?
Turning now to the day’s upgrades, mobile chipmaker ARM Holdings plc (ADR) (NASDAQ:ARMH) scored an upgrade to “buy” at the hands of Deutsche Bank.
Noting that ARM Holdings plc (ADR) (NASDAQ:ARMH) shares have fallen 20% since their May 2013 peak on worries of “market share loss to Intel Corporation (NASDAQ:INTC) following its new Silvermont mobile architecture launch and winning a tablet design with Samsung” and fears of “slowing high-end smartphone growth” overall, Deutsche is calling a bottom on the stock today. Quoted on StreetInsider.com this morning, the German banker suggested that “even if Intel Corporation (NASDAQ:INTC) gains 10% unit share by 2016,” and even if “a high-end slowdown” does materialize, investor worries over ARM’s valuation are still overdone.
I disagree. Priced north of 80 times earnings, and selling for nearly 63 times trailing free cash flow, ARM Holdings plc (ADR) (NASDAQ:ARMH) needs to grow its profits at least three times faster than the 22% annual growth rate that Wall Street is projecting for it in order to be fairly priced. Long story short, Deutsche is right that ARM remains a great business, with a great future — but the stock simply costs too much to be worth buying today.
