Market Moving Upgrades Worth Noting

Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Stocks can be pushed higher or lower as analysts provide their outlooks. These calls are not enough to base an investment on, but should be considered as part of your research. Therefore, I am assessing a few of last Wednesday’s top calls, and determining if each was a good call.

QUALCOMM (NASDAQ: QCOM)

On Wednesday shares of QUALCOMM (NASDAQ: QCOM) ticked higher by more than 2% after Sterne Agree offered some very encouraging guidance for its new Snapdragon 600 line. The firm believes that the line of products have gained significant share from last year’s MSM8960 processor and that the company’s chips could be included in up to 70% of all Samsung Galaxy S IV units.

The good news is that the 70% market share is much higher than in previous years, and it also diminishes the company’s dependence on Apple. In the past, QUALCOMM had been linked heavily to only Apple, but has since innovated and expanded with a more diversified approach. The company does have great margins, great growth, but I am a bit worried with its price/sales over 5.50. Now, I don’t think this one ratio alone is enough reason to sell the stock, but I do think it’s enough of a premium to not label the stock a “buy.”

Pacific Sunwear of California (NASDAQ: PSUN)

After a five-year 80% loss, Pacific Sunwear (NASDAQ: PSUN) has had a great start to the new-year with a 57% return. On Wednesday the stock got a boost of 7.56% after Piper Jaffray upgraded the stock to “Overweight.” The firm cited a survey which suggests sustained market share improvements and eventual profitability. As a result, the firm upgraded the stock from $2.50 to $3.00.

Personally, I have no problem with the call. The stock is very cheap with a price/sales of just 0.21 and could very well see a boost in demand. However, I am a bit curious of how a survey could predict future profitability. Did the survey track operational and spending changes or is it based on the firm’s expectation for increased market share? Who knows, but one thing’s for sure, the stock is on the uptrend and is still very cheap while the company has enough cash to operate for one more year without financing.

I view Pacific Sunwear as a high risk and a high reward investment, with my largest concern being its negative 58.85% return on equity. The company must make major strides in improving the effectiveness of its investments, and if so, then it has a lot of room to grow.

Merck & Co(NYSE: MRK)

In this market, you just about can’t go wrong investing in the healthcare space, specifically Big Pharma names. Jefferies tends to agree, upgrading the entire space. Yet Merck (NYSE: MRK) separated itself with gains of 3% on Wednesday, after Jim Cramer stated that the stock should be trading closer to $60 (currently priced at $47.00).

Cramer is right, despite Merck’s 23% gain over the last year, it still trades at just 12 times next year’s earnings compared to a 14 times earnings for the industry average. The company has a solid pipeline with at least five in late-stage development that could add significant sales in the next few years. Merck has felt the patent cliff woes, but has navigated it nicely by developing its pipeline. Therefore, I tend to agree with Cramer: From a valuation perspective, Merck is golden, and has the pipeline and clinical expertise to create large returns.

Conclusion

In my book, Taking Charge With Value Investing (McGraw-Hill, 2013) I discuss how to assess the opinions of analysts, and how to use them to your advantage. Typically, there are two types of calls: those that follow the trend and those who call regardless of the trend. It is important to distinguish between these two groups, and to not follow the performance that a call creates, but rather read and incorporate the notes as part of your research. Then, when you are able to find inconsistencies between value and valuation you will be better prepared to capitalize on the opportunity. 


Brian Nichols has no position in any stocks mentioned. The Motley Fool owns shares of Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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