Why Analysts Are Wrong About These Stocks

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Sell-side analysts can be notoriously fickle, seemingly raising or lowering price targets based simply on whether or not a stock is currently going up or down.

At the same time, though, sell-side research is still highly valued by institutional investors, including hedge funds and pension funds.

Recently, analysts at Goldman Sachs released a list of stocks they believe to be over-valued and ripe for a correction. Are they right to be bearish on these three stocks? Or are the analysts wrong to think these stocks are expensive?

Stocks drawing analyst ire

One stock entering Goldman’s cross-hairs is supermarket purveyor Kroger (NYSE: KR), which Goldman believes is over-valued by 10%. Indeed, shares of Kroger are up 50% just to start 2013. With gains like those over a roughly seven-month time frame, you probably couldn’t blame analysts for being pessimistic.

It’s worth noting, though, that Kroger’s share price gains have been accompanied by fantastic underlying results. Kroger’s first-quarter earnings per share rose 18% year over year and set a company record. Kroger’s total sales rose 3.4% versus the same period one year ago. In all, the quarter marked the 38th in a row of sales growth.

Kroger uses much of its stellar growth to reward shareholders in the form of dividends and buybacks. Over the past year, Kroger has returned $1.3 billion to shareholders.

And the future outlook remains promising, despite Goldman’s bearishness. Kroger increased its earnings guidance for the full year, to $2.73 to $2.80 per share, up from $2.71 to $2.79 per share previously.

Another stock on Goldman’s hit list is motion-control technology firm Parker Hannifin (NYSE: PH), which the investment bank believes is currently priced 11% above fair value.

Shares of Parker Hannifin are up about 22% to start the year, which sounds like a lot but is actually not significantly better than the overall market’s performance to begin 2013.

Parker Hannifin generated record sales in its recently-concluded fiscal fourth quarter, of $3.43 billion.

For the full year, sales clocked in at $13 billion, flat from the year prior. Cash flow from operations for fiscal 2013 was $1.2 billion, down slightly from 2012.

The company’s 2012 struggles are a reasonable explanation for Goldman’s negativity. However, the outlook for the current year is much more promising.

Parker Hannifin expects at least $7.35 in diluted EPS for the current year, which would represent 17% growth year over year.

Lastly, the team at Goldman has set its sights on GPS device manufacturer Garmin (NASDAQ: GRMN), which analysts believe could lose as much as a quarter of its value.

It’s not a stretch to say that Garmin is in trouble. There has been a well-documented shift in consumer behavior, as more people use their smartphones as GPS devices.

That being said, Garmin’s underlying results have yet to reflect a severe business deterioration. It’s true that the company’s biggest operating segment, Automotive, saw sales drop in the second quarter. But, Garmin’s other five segments each grew revenues year over year.  All told, net sales excluding the Automotive group rose 8% year over year.

And, the company's margins remain relatively intact.  Over the first half of the year, Garmin's profit margin dipped just one percentage point, but remains at a healthy 54%.

Valuations remain modest

Goldman’s pessimistic view on these stocks is surprising, because of the fact that these stocks hold cheaper valuations than the broader market.

The S&P 500 Index trades for a trailing earnings multiple in the high teens, and each of these stocks is more modestly priced than that.

Kroger trades for just 13 times trailing earnings, and Parker Hannifin exchanges hands for 16 times trailing EPS. Garmin, meanwhile, trades for just 14 times trailing EPS, so even though there’s reason to believe its business is in trouble, it’s not as if the stock is priced for perfection.

And, each of these stocks provides their investors with a measure of downside protection in the form of dividend yields. In particular, Garmin offers an outsized yield of 4.6% annualized, meaning investors are at least paid well to wait for the company to chart itself a better path going forward.

The bottom line

Sell-side analysts are obviously extremely knowledgeable and have deep insights into the operations of the businesses they cover. At the same time, though, too often it seems upgrades or downgrades are reactionary and not forward-thinking.

These stocks' valuations are still reasonable, provide the downside protection of solid dividend yields, and their future outlooks are optimistic. Quite simply, the analysts have missed the point on these stocks, and investors should continue to own them with confidence.

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Robert Ciura has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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