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 new upgrades for Visa Inc (NYSE:V) and UnitedHealth Group Inc. (NYSE:UNH), but downgrades for both The Home Depot, Inc. (NYSE:HD) and Lowe’s Companies, Inc. (NYSE:LOW). Let’s take them in order:
Credit card company Visa missed earnings estimates last month, but with the bad news out of the way, Swiss megabanker UBS decided to remove its sell rating on the stock this morning, and upgraded to neutral. According to the analyst, Visa’s doubling down on full-year guidance, plus its modest dividend yield and promises to buy back stock are providing a “floor” to the stock’s price, limiting downside risk.
Unfortunately, the analyst is wrong.
Priced at nearly 44 times earnings today after the past year’s 33% gains, Visa’s stock is vastly overpriced even if it does manage to grow earnings at the 18% annualized rate Wall Street has it pegged for. As for the dividend, an 0.8% yield is hardly something to crow about. And topping it all off, Visa’s vaunted free cash flow has slowed to a dribble, as the company generated just $524 million in real cash profit over the past year — far lower than its $2.4 billion in claimed GAAP earnings.
In short, UBS may see the bad news as past. I think it’s only just beginning.
United Healthcare: Healthy once more?
Meanwhile, over at Oppenheimer, investment bankers are even more optimistic about the valuation at the nation’s biggest health insurance provider, UnitedHealth Group — and this time, they’ve got more of a leg to stand on.
Oppy thinks UnitedHealth is priced to “outperform” the market, and that shares will rise to $66 over the course of the next 12 months. The company’s 11% projected growth rate, 10.4 P/E ratio, and modest 1.5% dividend yield all suggest the analyst is right about that — the stock is undervalued.
Based on its “total return” ratio — predicted earnings growth plus dividend yield — of 12.5 today, a rough estimation of the stock’s true worth shows UnitedHealth to be about 17% undervalued at today’s prices. Thus, a 20% move such as the one Oppy suggests looks entirely reasonable, and the analyst’s $66 price target — right on the mark.
Home Depot and Lowe’s
It’s not all good news and happy talk today, however. While UBS and Oppenheimer were busy making their picks, analysts over at Stifel Nicolaus produced a pair of pans, downgrading both of the nation’s biggest home improvement retailers to “hold.”
Does it seem unfair to lump Home Depot and Lowe’s together in one shopping basket… and then shove that basket out into traffic? It’s not. In fact, with both stocks trading at a P/E ratio of roughly 23, both paying about a 1.6% dividend yield, both struggling under sizable debt loads, and both pegged for about 16% long-term earnings growth, it’s actually harder to tell these two stocks apart than to just lump ’em together and declare: “I’m not impressed.”
Although it’s true that if the home improvement giants succeed in hitting their numbers, and producing growth at the expected rates, they’re not dreadfully overvalued at today’s prices; neither are they cheap. When you’re already selling $50 billion (Lowe’s) or $70 billion (Home Depot) worth of goods annually, growing that number 16% a year, for five straight years, is no easy trick.
Considering the high P/E ratios that both stocks sport, I’d say the downside risk here quite simply eclipses any gains shareholders may see from trying to capitalize on a strengthening housing market. Stifel’s right to warn investors away.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Home Depot, Lowe’s, UnitedHealth Group, and Visa.
The article Thursday’s Top Upgrades (and Downgrades) originally appeared on Fool.com and is written by Rich Smith.
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