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 at both Bed Bath & Beyond Inc. (NASDAQ:BBBY) and Deckers Outdoor Corp (NASDAQ:DECK) . But the news isn’t entirely bleak, so before we get to those, let’s find out why one analyst thinks…
General Dynamics Corporation (NYSE:GD) has a fighting chance
A funny thing happened on the way to President Obama’s 2014 budget proposal. Somehow, someway, a budget that was supposed to cut $41 billion in defense spending under sequestation actually reduced requested spending by less than $4 billion from 2012 levels. This development has one analyst — Drexel Hamilton — thinking things might not turn out so badly for defense contractors like General Dynamics Corporation (NYSE:GD) after all.
In a note released Thursday, Drexel relented on its “sell” position on General-D — and also on Lockheed Martin Corporation (NYSE:LMT) and Northrop Grumman Corporation (NYSE:NOC) , incidentally — upgrading all three stocks to neutral. Now, of the three, the upgrade of General-D looks most curious. Both Lockheed and Northrop are GAAP-profitable operations. General Dynamics, in contrast, is reporting GAAP losses. So why upgrade it?
Here’s why: Despite reporting “losses” under generally accepted accounting procedures, General Dynamics Corporation (NYSE:GD) still generated more than $2.2 billion in free cash flow last year. This gives the stock a price-to-FCF ratio of only 11, which seems a fair price if GD continues paying out a 3.2% dividend, and growing profits at 7.1%, as it was projected to do under the sequester. On the other hand, if GD can grow faster than that — if for example, defense spending doesn’t get cut as much as it was expected to only a few days ago — then the stock could be even cheaper than it looks. It might even deserve an upgrade to buy.
Now for the bad news
At the same time as Drexel was upping its opinion of General Dynamics Corporation (NYSE:GD), Lockheed Martin Corporation (NYSE:LMT), and Northrop, independent analyst Standpoint Research was downgrading its opinion of a pair of retailers. On Wednesday, Standpoint cut its rating on each of Deckers Outdoor and Bed Bath & Beyond Inc. (NASDAQ:BBBY), to hold. Here again, though, while I agree with the sentiment, I think the analyst isn’t going far enough with its ratings moves.