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5 Downgraded Stocks That Should Be Buys - 13482 views
MINNEAPOLIS (Stockpickr) -- Many books could be written discussing the virtues -- or lack thereof -- of Wall Street research. What probably began as an innocent extension of the brokerage business has since become something loathed by many yet still relied upon by the majority of market participants. Like it or not, analysis from the supposed best and brightest financial minds is here to stay.
Individual investors first began questioning Wall Street research during the dot-com boom. The media helped put a spotlight on research during those heady times, when stocks would soar on demand-fueled hope. Often long after the gains, a Wall Street analyst would put a buy recommendation on the stock. On the downside, a stock like Enron or Worldcom would collapse, and only after substantial losses would Wall Street come forward with a sell recommendation.
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Many investors believe that the much of what passes for research lacks individual thought and usually comes a day late and a dollar short.
To be fair, there are plenty of analysts adding value to the investor equation, but it has been my experience that most of what comes out of Wall Street is worthless. In fact given the institutionalization of research, there is an opportunity to take advantage of the system as it stands.
On a weekly basis, I use analyst estimates of earnings to identify trading opportunities. Today, I want to use Wall Street downgrades to help identify investing opportunities. Although the industry has gotten much better with respect to downgrades before a stock sells off, there are plenty of examples where they are still far too late to the game to save anyone any money.
With that in mind, here are five recently downgraded stocks to buy today.
The devastation caused by the earthquake and tsunami in Japan crippled the economy there, at least in the short term. The country is a huge player in the auto industry, and with manufacturing virtually shut down during the immediate aftermath of the earthquake, reverberations were felt across the globe. Shares of Toyota Motors (TM) collapsed.
Since early March, Toyota shares have dropped by more than 25%. At the end of August, Credit Suisse downgraded the stock to neutral from overweight -- and shares moved higher by 2% on the day of the downgrade. The time to sell this stock was shortly after the earthquake, not months afterward.
Toyota remains one of the dominant players in the auto space. Despite the challenges presented by events in Japan this year, the company beat analyst estimates by 5 cents per share in the quarter ended June 30. For the full year, the average Wall Street estimate is for Toyota to make $2.75 per share. In the following year, profits are expected to jump to $5.02 per share.
Investors can buy that 80% growth for just 25 times current-year estimated earnings. I’m not sure what the Credit Suisse analyst is thinking here. I would buy Toyota at these prices.
Solar stocks have been sold heavily in 2011 as the industry has struggled, with weak economies across the globe and excess supply of solar panels. Trina Solar (TSL) shares have dropped a whopping 74% since the beginning of May.
On Sept. 14, Jefferies downgraded Trina Solar to hold from buy and lowered its price target on the stock to $10 from $21. From current prices, the $10 target would represent a 35% gain on the stock. I don’t know about you, but buying a stock for a 35% gain seems like a good idea to me.
The downgrade makes little sense here. The average Wall Street estimate for the company this year is $1.63 per share. In the following year, profits are expected to grow by 18% to $1.92 per share. At current prices, investors can buy the stock today for 5 times current-year estimated earnings. This stock is a buy, not a hold.
Varian Medical Systems
Varian Medical Systems (VAR) is medical device company specializing in x-ray technology for the treatment of various cancers. Shares fell off the cliff in mid-July with the rest of the market. Unlike the rest of the market, which has rallied nicely off its lows, Varian remains stuck in the mud.
On July 28, with the stock down 17%, Robert W. Baird downgraded the stock to neutral from outperform. The Wall Street firm lowered its target of Varian to $72 per share -- some $10 higher than the price of shares on the day of the downgrade.
To Baird’s credit, Varian shares continued to fall in August and September, dropping to a low of $50.11 per share. Today the stock is slightly higher at $51.75. With a target of $72, it would appear that Varian has upside potential of 40%. I would think Baird would upgrade the stock with that dynamic.
Wall Street firms tend to be reluctant to change ratings frequently to avoid the appearance of flip-flopping, but that's not always in the best interest of investors. With the stock trading for just 15 times expected earnings and Wall Street expecting those earnings to grow by 15%, Varian is a buy.
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The market is a forward-looking instrument. Investors read the tea leaves, forecast future cash flows and discount appropriately to determine value. When a stock sells off, it's usually because storm clouds are on the horizon. On Sept. 12, Wunderlich downgraded LED manufacturer Cree (CREE) to sell from hold. Citing a forthcoming downtrend in demand due to weakening consumer spending, the Wall Street firm lowered its target from $34 per share to $25 per share.
Tell me something I don’t already know, please. The market has long been anticipating a slowdown for Cree. Shares are down 51% year-to-date. A lower price due to weak demand is no secret. The time to make this downgrade would have been at the start of the year. Today, it might be time to buy Cree.
The average Wall Street estimate for earnings for the year ending June 30, 2012, is $1.42 per share. In the following year, profits are slated to grow by 37% to $1.95 per share. At current prices, shares of Cree trade for 23 times current-year estimated earnings. Even if profits miss the mark due to lower demand, there is room in the valuation for shares to appreciate -- or at a minimum maintain current value.
Cree is far from a sell, in my opinion. I would buy the stock.
A Wall Street downgrade can be a powerful thing. Case in point is the Tuesday downgrade of Molycorp (MCP) by JPMorgan to neutral from overweight. The analyst also slashed his price target on the stock to $66 from $105. That drastic change of opinion spooked investors, and shares sank 20%.
In this case, the opportunity for investors is to take advantage of the irrational drop in share price. Prior to the rating cut, Molycorp had been on an impressive roll. Higher commodity prices fueled gains of this rare earth miner over the last 12 months. Including Tuesday’s loss, Molycorp is still up some 69% in that time.
At current prices, a $66 target would net a gain of 63%. Let’s take the downgrade at face value and assume the analyst is correct in predictions of less demand for rare earth tonnage. That demand would have to fall pretty hard not to justify a higher stock price for Molycorp.
The average Wall Street estimate for profits in the current year is $1.95 per share. Next year, the profit forecast more than doubles to $4.03 per share. At current prices, the stock trades for 21 times current year estimates. Profits could come in far below current expectations and the stock would still be cheap.
This one is an easy one to buy, thanks to the power of the analyst. I would buy Molycorp at these levels.
-- Written by Jamie Dlugosch in Minneapolis.
To see these stocks in action, visit the 5 Recently Downgraded Stocks to Buy Today portfolio.
At the time of publication, author had no positions in stocks mentioned.
Jamie Dlugosch is a founder and contributor to MainStreet Investor and MainStreet Accredited Investor. Formerly, he was president and CEO of Al Frank Asset Management. He has contributed editorially to The Rational Investor, The Prudent Speculator, Penny Stock Winners and InvestorPlace Media.