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 feature a downgrade for homebuilder NVR, Inc. (NYSE:NVR), but an upgrade for Masco Corporation (NYSE:MAS) — and for AeroVironment, Inc. (NASDAQ:AVAV), an increase in price target. Let’s dive right in.
Are homebuilders in trouble?
On the front page of today’s Wall Street Journal, banker Wells Fargo & Co (NYSE:WFC) is quoted warning investors at a banking conference of an impending 28% drop in mortgage originations in Q3. A few lines down, JPMorgan Chase & Co. (NYSE:JPM) chimes in with its own worries that it’s likely to lose money on mortgage originations in this year’s second half.
And continuing the theme, this morning we learned from StreetInsider.com that Swiss megabanker Credit Suisse has just downgraded homebuilder NVR, Inc. (NYSE:NVR)… to underperform. Credit Suisse hates NVR more than it hates either Beazer or D.R. Horton — two other homebuilders it downgraded today, but only to neutral. It likes NVR, Inc. (NYSE:NVR) a whole lot less than rival M.D.C. Holdings, the only homebuilder the banker decided to upgrade.
But why would you want to take Credit Suisse’s advice about these stocks?
Let me count the ways. Comparing the two companies at the opposite ends of Credit Suisse’s ratings scale, NVR, Inc. (NYSE:NVR) costs more than 22 times earnings. MDC costs only five times earnings. Valued on their assets, NVR, Inc. (NYSE:NVR) costs more than 3.1 times book value; MDC — less than 1.3. And of course, at the most basic, tangible level, MDC pays its shareholders a generous 3.6% dividend yield… while NVR, Inc. (NYSE:NVR) pays zilch.
If ever an analyst was painting an argument for making a “paired trade,” selling one stock short, and using the money to buy another, similar, but cheaper stock — Credit Suisse appears to be making that case for us today.
Aside from homebuilders, are there other opportunities in housing?
Despite rumors of an impending decline in mortgage originations, all’s not entirely bleak in the homebuilding sector, as Credit Suisse’s upgrade of MDC makes clear. And indeed, other analysts think they see additional opportunities to invest in a housing market that may not be done running just yet. (As we’ll see in a moment, they’re wrong… but still worth considering, just to see what the analysts are saying).
Take cabinetmaker Masco Corporation (NYSE:MAS) for instance. This morning, analysts at Oppenheimer announced an upgrade of Masco shares to outperform, predicting that housing market “tailwinds” will continue, and will help lift the stock to $25 within a year. According to Oppy, “[Channel] checks indicate [that the] positive momentum MAS cited in July … persisted through the summer, setting [the stock] up for a strong 3Q13.” Indeed, even assuming Masco Corporation (NYSE:MAS) fails to achieve its targeted 30% gross margins in 2014 and 2015 (the company’s grossing about 26% right now), Oppenheimer still likes the stock’s chances, as sees the potential for a 20% gain in share price.
But is Oppenheimer right? Can stronger margins, and stronger sales, make Masco Corporation (NYSE:MAS) a buy?
I wish I could say yes, but it’s hard to see how the analyst could be right. Priced at 150 times earnings today, Masco’s stock looks far too overvalued to ever have any chance of outperforming the market. Sure, over the past 12 months, Masco Corporation (NYSE:MAS) generated some $218 million in positive free cash flow from its business, which is more than four times as much cash profit as the $52 million in “net income” the company was allowed to report under GAAP.