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 an upgrade for Thomson Reuters Reuters (TRI +0.32%), a new buy rating for Novavax (NVAX 1.44%) -- but for Union Pacific (UNP +0.34%), a downgrade. Let's get that bad news out of the way first.
Union Pacific derailed
Two weeks after railroad operator Union Pacific reported Q3 earnings that topped analyst estimates by a penny, the stock got its reward today: a downgrade at the hands of investment banker R.W. Baird.
Coming on top of the 4% slide the stock has experienced since reporting its "beat", Baird's recommendation seems a bit harsh -- like adding insult to the injury that Union Pacific shareholders have seen inflicted on their portfolios. And yet, when you look at the numbers, it's apparent that Baird's making the right call in downgrading to neutral.
Priced at 16.5 times earnings, Union Pacific shares sell for a valuation right in the middle of the pack of North America's bigger railroad operators, where Canadian National Railway, for example, costs more than 18 times earnings -- but CSX sells for just a hair over 14 times.
The stock's valuation today also looks appropriate when considering the railroad on its own merits. Indeed, a valuation of 16.5 times earnings may even be a bit generous. The stock pays a 2.1% dividend yield, but is expected to grow earnings at less than 14% annually over the next five years. UP's quality of earnings is also a bit suspect, inasmuch as the company only generated about $3.2 billion in free cash flow over the past 12 months -- about 25% less than its $4.25 billion in reported net earnings.
Long story short, while a fine business, Union Pacific's share price looks a bit frothy today. Given that the stock has risen 22% already over the past year (yes, even after the recent sell-off), I'd say Baird is correct to be injecting a note of caution, and urging investors to back away from the shares until they offer better prices.
Is Novavax stock the cure for what ails you?
Happier news greeted investors in vaccine maker Novavax this morning. FBR Capital announced today that it's initiating coverage of the stock with an outperform rating, and assigning an $11 price target. As the analyst explains: "We view the company's pandemic vaccine development efforts as promising, but until stockpiling plans are better understood, we find it difficult to ascribe much value to the programs." Yet even so, "Novavax [is] one of the most compelling small-cap vaccine plays in the biopharma sector by virtue of the vaccine for preventing RSV infection."
And yet, if this all sounds a bit speculative -- one drug may be "promising", and another just a "play" -- there's a reason for that.
It is speculative. The fact remains that, no matter how "compelling" FBR finds Novavax as a potential investment, it's going to be hard to put much confidence in the analyst's $11 stock price guess, especially given that to date Novavax remains a company devoid of profits, and nearly devoid of revenues.
Long story short, FBR's endorsement is helping to send Novavax stock up 10% today, but with the stock's P/E remaining stuck at literally "infinity", an investor can't really be sure that this is the beginning of a multibagger rally, or just another blip on a very volatile stock chart, doomed to evaporate like so many before it.
Extra! Extra! Read all about it!
Finally, we come to Thomson Reuters Reuters -- owner of the famous journalism brand name, and a major force in financial and legal publishing as well.
Yesterday, Thomson Reuters reported Q3 earnings that beat Wall Street estimates by $0.04. At the same time, the company disclosed plans to shed 3,000 workers from its payroll in an effort to further reduce costs, and further boost profits. These twin "good" news announcements convinced analysts at National Bank to upgrade Thomson Reuters stock one notch to sector perform, even as investment banker RBC Capital Markets went a step further and upgraded the shares to outperform (with a $40 price target).
But will Thomson Reuters really rise so far?
After all, with a P/E ratio approaching 34 times earnings, the stock's valuation already looks stretched at the $37 and change the shares fetch today. Most analysts agree that Thomson Reuters will grow earnings by about 2% a year over the next half decade. Indeed, the company only managed a 2% increase in revenues this past quarter -- suggesting growth estimates may be on the mark.
Granted, Thomson Reuters remains a strong cash generator (free cash flow for the past 12 months approached $1.7 billion, or nearly twice reported earnings under GAAP). But still, the company's slow growth rate suggests that even if you think of Thomson Reuters as being a stock selling for "18 times free cash flow" rather than "34 times earnings", the stock's fully valued either way -- and far from a bargain.
On balance, while I'm more inclined to agree with National Bank's conservative sector perform rating than with RBC's more aggressive outperform -- the truth is that I think both analysts are being too optimistic here. I think Thomson Reuters is overvalued, and until it gets its growth engine going again, it's likely to remain range bound for the foreseeable future.
Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool owns shares of CSX.
