Using Upgrades and Downgrades to Find Investments - TheStreet

Using Upgrades and Downgrades to Find Investments

You can use our daily rating changes to revisit your watch-list ideas or to reassess your current holdings.
Author:
Publish date:

We run our model every day for which we have incremental data, so there are upgrades and downgrades virtually every day (it's very rare that we'll have no changes). These daily changes in assessments are fertile ground for digging up new ideas, and great opportunities to revisit either your watch-list ideas or to reassess your current holdings.

As pointed out in our primer and introductory missives, when we are outside of earnings season, chances are that any upgrade or downgrade was driven by price movements or by comparisons to industry peers' assessments. Here's an example of one stock that the model had upgraded some time ago, but then had been downgraded for a time, only to come back into the favored circle of potential portfolio picks last week. The stock is

Covidien

(COV)

.

The model loves this company's Growth characteristics. Scoring 4.5 out of 5 stars on our Growth index, COV posted stellar earnings growth in the most recent quarter, as compared to the same quarter a year earlier. It grew net income by close to 125% in the second fiscal quarter (reported back in April), and did even better than that at the EPS level. This came despite revenues that were 5% lower than those of the previous year, on a GAAP basis. Adjusting for foreign currency movements (COV makes almost half its sales overseas), revenue dropped by about 8%. Not bad, considering the tough environment for the company.

Management issued solid guidance for the year ahead, but the stock fell back as investors continued to digest the new Healthcare laws enacted in the US, and pondered foreign currency issues facing the firm. One very important thing to keep in mind when studying healthcare stocks is that some of their largest customers are governments. These huge bargaining partners have leverage in negotiations with suppliers. However, keep in mind as well that high-quality gear is necessary in this business, so there's a floor regarding how much big customers can hit companies' top lines.

The model also appreciates COV's dividend, which, at a yield of about 1.7%, pays a decent amount to keep investors interested while they await share price growth. The rest of our indexes are only so-so for this firm: Total Return factor is only 2.5 out of 5, while Efficiency is 3 out of 5, Price Volatility is 3 out of 5, and Solvency is 3.5 out of 5. What's important to determine before taking the plunge and buying COV shares is whether: 1) you think that solid, consistent growth can be maintained, and that some of the more important factors such as Efficiency and Solvency can be improved (we think so, and add that 3.5 out of 5 is not bad at all, considering alternatives). If you agree, then you'll likely agree that Total Return is also likely to improve as a consequence.

Covidien is a diversified manufacturer and distributor of medical devices, pharmaceuticals and medical supplies. Details about exactly what they manufacture and distribute are widely available, and as a rule we would urge investors to familiarize themselves with the fundamentals as a follow-up analysis to the quantitative elements we present here. However, the highlights include: a very solid presence in hospitals, with exposure to the surgical suite, the pharmacy and the supply closet. The firm began its current incarnation as a spinoff from the ill-fated conglomerate, Tyco, and hasn't looked back. Since the spin, COV has whittled its product portfolio down and beefed it up as well, focusing on increasing exposure to faster-growth, higher-margin products. We think that the stock is worth a look. It hovers around the low-$40s currently, and our model has a price target in the mid-$50s as of our last report.

As we have seen, the Ratings model can seem rather conservative to some investors. However, even for folks who are more aggressive than the "investor" that is the model, using the screener can yield stocks that are more to your individual taste. By isolating the different factors, investors can find stocks that exhibit characteristics they prefer. Try out our

screener

and see what you think.

-- Reported by Don Lucek in Boston, MA.

Don Lucek, equity research manager, joined TheStreet.com Ratings after working as a buy-side equity analyst with Boston Private Value Investors and as a fundamental equity analyst with DE Investment Research. Prior to that, Don gained experience in credit analysis and international business management, working in the financial services sector. He earned his Bachelor's degree in Economics at Boston College, and received his International MBA degree from the HEC School of Management in Paris. Don is a Level III candidate in the CFA Program.