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 downgrades for Domino’s Pizza, Inc. (NYSE:DPZ) and Aeropostale, Inc. (NYSE:ARO). But the news isn’t all bad, so before we get to those two, let’s take a quick look at why…
American Eagle could fly
The day starts out bright for owners of American Eagle Outfitters (NYSE:AEO) stock. After crunching the numbers on True Religion Apparel, Inc. (NASDAQ:TRLG)‘s recent buyout, independent analyst Standpoint Research has concluded that there’s value to be had in the shares of a rival teen retailer — American Eagle Outfitters (NYSE:AEO).
Standpoint upgraded shares of AE to “buy” this morning, and it’s not hard to see why. Priced at 17.3 times earnings, AE stock sells at a sizable discount to the more than 22 times earnings that TowerBrook Capital is paying for After crunching the numbers on True Religion Apparel, Inc. (NASDAQ:TRLG). Plus, at 11% projected earnings growth over the next five years, AE is growing nearly twice as fast as TR.
Adding to the attraction, AE generated $381 million in real free cash flow over the past year — 64% more than the $232 million in GAAP earnings the company reported. By my calculations, this has AE shares selling for a very attractive 10 times FCF valuation, and selling at a discount based on 11% earnings growth. Throw in a tidy 2.2% dividend yield, and right there, folks, you have yourself a market-beating investment for the taking. Standpoint is absolutely right to upgrade it.
Aeropostale — lost in the mail?
Now on the other hand, the news isn’t quite as good for another of the “A-list” teen retailers. At the same time as Standpoint was urging investors to buy AE, you see, this same analyst was downgrading shares of Aeropostale, Inc. (NYSE:ARO) to “hold.”
Why? Again, the numbers tell the tale.
Priced at 38 times earnings, or even at the more attractive-sounding 17 times free cash flow, Aeropostale, Inc. (NYSE:ARO) is pretty obviously more expensive than rival American Eagle Outfitters (NYSE:AEO). It’s even arguably more expensive than After crunching the numbers on True Religion Apparel, Inc. (NASDAQ:TRLG), meaning that the buyout price paid for TR holds out little promise for Aeropostale, Inc. (NYSE:ARO) owners.