Joy Global Inc. (JOY), Caterpillar Inc. (CAT), Microsoft Corporation (MSFT): Wednesday’s Top Upgrades (and Downgrades)

But is Baird cutting bait too soon? After all, the analyst’s new price targets suggest there’s still at least a few dollars’ worth of upside left in both stocks. Nor do either Joy Global Inc. (NYSE:JOY) or Caterpillar Inc. (NYSE:CAT) look particularly expensive — at least on the surface. Joy shares cost only 7.8 times trailing earnings, while Cat shares fetch 13.6 times earnings. With estimates for earnings growth in the mining industry still averaging 13.6% annually over the next five years, this would appear to suggest that Caterpillar Inc. (NYSE:CAT) is at worst fairly priced, and Joy Global Inc. (NYSE:JOY), potentially a bargain.

Don’t believe it.

Both of these stocks’ purported GAAP “earnings” are actually of extremely low quality, raising the risk they could decline in short order. Financial data provider S&P Capital IQ reports that actual free cash flow at Joy Global Inc. (NYSE:JOY)  is only $457 million for the past 12 months — just 64% of reported net income. Caterpillar Inc. (NYSE:CAT) did a little better than that, but only just barely. It generated only $2.9 billion in free cash flow over the past year — 68% of reported net income.

What this suggests to me, as a value investor, is that both stocks are roughly half-again more expensive than their P/E ratios make them look, and correspondingly, 50% less attractive to invest in.

Long story short, Baird is correct to be cautious, and right to downgrade the stocks.

The article Wednesday’s Top Upgrades (and Downgrades) originally appeared on Fool.com and is written by Rich Smith.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool owns shares of Microsoft.

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