Now, that doesn’t sound like an unreasonable number. But analysts only expect to see the company grow in profitability at about 13.6% per year over the next five years. Even with a generous 2.2% dividend yield, GameStop Corp. (NYSE:GME) shares look overvalued today — and unlikely to reach Telsey’s $58 price target.
Applied rethink
And finally, Applied Materials, Inc. (NASDAQ:AMAT). After initially slipping in after-hours trading, following news that the company had “missed earnings” and decided to switch CEOs mid-year, Applied shares are on the upswing again today. For this, you can probably thank the friendly analysts at D.A. Davidson — who this morning upgraded Applied Materials, Inc. (NASDAQ:AMAT) shares to “buy” and assigned an $18 price target.
At first glance, this upgrade looks a lot like Telsey’s recommendation for GameStop. Like GameStop, Applied Materials, Inc. (NASDAQ:AMAT) is afflicted by the stigma of negative GAAP profits at present. Also like GameStop, however, Applied has abundant free cash flow arguing in its favor.
Applied’s latest report shows that cash profits at the company amounted to $834 million over the past year, giving the company a 23 times price-to-free cash flow ratio. That’s probably too much to pay if analysts are right and Applied is only going to grow its profits at about 9% per year over the next five years. On the other hand, management advised yesterday that it sees “fab equipment investments … up 10% to 20% relative to this year,” which suggests the company could actually grow faster than the analysts are projecting. (On the other other hand, though, Applied also warned yesterday that it thinks its gross margins will probably keep falling for the next couple of quarters, blunting the effect of any projected sales gains.)
When you get right down to it, though, I think the upshot is this: 20% sales growth in the best-case scenario only suggests a fair valuation on Applied Materials, Inc. (NASDAQ:AMAT) shares today. Meanwhile, the potential for 10% sales growth, and even slower profits growth (due to the declining margins) suggests significant risk that profits won’t grow fast enough to justify the valuation on Applied Materials, Inc. (NASDAQ:AMAT) shares. On balance, this looks like a stock that’s too risky to buy, and investors are probably better advised to use this morning’s price-spike as an occasion to exit the shares.
The article Friday’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 GameStop.
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