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 higher price targets for Johnson & Johnson (NYSE:JNJ) and Tripadvisor Inc (NASDAQ:TRIP). But it’s not all good news, so before we get to those stories, let’s take a look at why…
Gordmans Stores got marked down
On a bright day for markets in general, shareholders of Gordmans Stores, Inc. (NASDAQ:GMAN) are feeling kind of left out.
Why? Despite beating earnings last night, and meeting revenue expectations as well, the company’s getting punished for a 4% decline in same-store sales, with the damage compounded by downgrades to “hold” from analysts at Stifel Nicolaus and Piper Jaffray today.
Piper in particular is hurting the stock by saying it thinks Gordmans’ shares will be worth only $13 a year from now. Considering that they cost more than that before the earnings beat (and cost less than $12 right now), that’s not very good news. It’s also not (necessarily) correct.
With Gordmans priced at just nine times earnings today, most analysts have it pegged for robust, 15% annual earnings growth over the next five years. All things being equal, that should be plenty fast enough to justify a nine-times multiple to earnings for Gordmans shares. The main worry here, for investors, should be the facts that (a) Gordmans has been reporting pretty weak free cash flow numbers these past few quarters, and (b) the company’s earnings report last night contained no update on the cash flow situation. Absent robust free cash flow, it’s hard to say how much Gordmans’ reported “earnings” are really worth… or whether they’re worth even the $13 a share that Piper posits.
No Band-Aids needed
Better news greeted shareholders of medical products giant Johnson & Johnson (NYSE:JNJ) today, as Swiss megabanker UBS upped its value estimate on the shares $6 to a new $87 target. Details on UBS’ move are sparse right now… but I’m going to go ahead and diss it anyway.
Why? There’s no denying J&J is a giant in the industry, a superb business and one that will be around for decades to come. Where my disagreement with UBS lies is in the banker’s suggestion that it’s a good idea for you to buy a stock that costs 21 times what it earns in a year… when the company’s only expected to grow these earnings in the mid-single digits over the next five years.
Twenty-one times earnings is a high price to pay for sub-7% growth, even with Johnson & Johnson (NYSE:JNJ) paying a 3.1% dividend yield to help make up the difference. The stock’s a better bargain when valued on free cash flow, granted, which at $12.5 billion exceeds reported income by about 15%. But it’s still not cheap enough to own.
Time to hit the road with TripAdvisor?
Finally: Tripadvisor Inc (NASDAQ:TRIP). This company’s a bit like Johnson & Johnson (NYSE:JNJ), inasmuch as TripAdvisor, too, generates superior cash profits. The $210 million in free cash flow it churned out last year was about 8% above reported GAAP income. Unfortunately, and also like J&J, TripAdvisor shares still cost too much despite the superior free cash flow, and also despite the fact that this company is growing much, much faster than J&J.
I calculate a price-to-free cash flow ratio of 35.5 on Tripadvisor Inc (NASDAQ:TRIP) shares today. Even with the company’s projected 16% annual growth rate, that’s a high price to pay. It’s also, incidentally, probably the reason investors are shrugging off Stifel Nicolaus’ endorsement of the stock today, and ignoring its suggestion that the shares could reach $58 a year from now.
$58 a share could happen, sure… but that would just make TripAdvisor’s overpriced shares even more overpriced than they already are — and more likely to fall right back down again.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Johnson & Johnson and TripAdvisor. The Motley Fool owns shares of Johnson & Johnson and TripAdvisor.
The article Tuesday’s Top Upgrades (and Downgrades) originally appeared on Fool.com and is written by Rich Smith.
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