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 tech stalwarts Adobe Systems Incorporated (NASDAQ:ADBE) and Symantec Corporation (NASDAQ:SYMC) . But it’s not all bad news, so why don’t we start out with a few words on why one analyst thinks …
This company is the Cat’s meow
Wednesday opened happily for shareholders of mining and construction equipment maker Caterpillar Inc (NYSE:CAT) . Predicting that the company is capable of earning $10 a share annually by 2014, analyst Standpoint Research initiated Cat-coverage with a buy rating and a $105 share-price target. And while Standpoint admits there are “concerns regarding China and inventory levels,” the analyst notes that with Cat’s share price off 24% from its recent high, these worries are “already reflected in the share price.”
Be that as it may, here’s one worry that isn’t reflected: free cash flow.
Even if Caterpillar Inc. (NYSE:CAT) does manage to “earn” $10 a share next year, you see, there’s a big question about the quality of these earnings. Cat reported total net earnings of $5.7 billion last year; however, the amount of actual cash profit it generated — its free cash flow — was an anemic $165 million.
On Cat’s $56.8 billion market cap, that works out to a simply staggering price-to-free cash flow ratio of 344 — and that’s not even penalizing the company for its nearly $37 billion debt load. Even crediting the company for its strong projected rate of 14% earnings growth, therefore, I’m afraid this stock is simply too overpriced to buy.
Adobe Systems Incorporated (NASDAQ:ADBE)’s not looking so solid today
So what might you buy instead? Not Adobe, certainly. This morning, Goldman Sachs Group, Inc. (NYSE:GS) responded to Adobe’s giving of below-consensus earnings guidance yesterday by reiterating its sell rating on the stock, while raising its price target. Meanwhile, ace analyst Stifel Nicolaus went a step further and actually downgraded Adobe shares, to “hold.”
On balance, I think I side more with Goldman’s sell recommendation than with Stifel’s belated hold. On one hand, when valued on GAAP earnings, Adobe looks like a clear “sell” because its shares cost nearly 30 times earnings, despite earnings growth rate projections that fall short of 11%.
On the other hand, Adobe Systems Incorporated (NASDAQ:ADBE) looks like almost as clear a “sell” based on its free cash flow number. Last year, Adobe’s cash profits of $1.2 billion dwarfed its reported income of only $713 million. Yet on a $21.2 billion market cap, the company still scores only a 17.3 for its price-to-free cash flow ratio. With no dividend yield to bridge the gap, that’s simply too high a price to pay for 10%-and-change profits growth. In short, any way you look at it, the stock’s overpriced. Hold it or sell it as you prefer — but just make sure not to buy Adobe Systems Incorporated (NASDAQ:ADBE).