NEW YORK (TheStreet) -- From this analyst's perspective, there has always been an art to issuing a stock upgrade. First, you have to know when to time it so it receives maximum attention. Usually, just before an earnings release or after a horrific plunge in the stock price based on some news event will garner the most visibility. The second piece to the puzzle is clearly stating why the upgrade is happening at this point in time. Has the market overreacted to otherwise bad news? Has the market shrugged off news that should be valued higher given its impact on future earnings and cash flow?
All of these factors are key considerations, and often investors are advised to chase analyst upgrades or rising earnings estimates with little attention paid to the actual research.
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This "buying with your eyes closed" could lead to trouble, however. So keep these rules of thumb in mind when seeing upgrades. In order to buy into the upgrade news, you want to see these basic things:
1) There is something fundamental on the near-term horizon -- a new product or service -- that is not being properly valued on the Street. For example, if XYZ Tool Co. has a key hammer being launched in the fourth quarter, yet the stock just got nailed on a dreary third-quarter earnings report, I suspect an analyst upgrade would occur on the hope the new hammer reignites sales over coming quarters.
2) A company is reviewing its cost base. Reviews of this nature usually take a few months, and tend to lead to cost-savings announcements (or, a Hewlett-Packard-type breakup) that cause the Street to overlook weak sales.
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Again, these are not blanket statements. They're simply a guidepost to be applied to individual companies.
Here are a few stocks that have come up on my radar screen for recent upgrades or potential upgrades.
Target (TGT) caught an upgrade this week, and I believe a couple more are likely in the works into the company's earnings report next week. Although I have been a serious bear on Target for about a year and still have major reservations on the state of its operations in Canada, the upgrades are starting to make sense to me.
I like the new products flowing into the stores (TOMS products arrive on Nov. 16). I even like the new CEO Brian Cornell. The one thing holding me back from issuing a pre-earnings upgrade is the promotional cadence at the store level -- from food to apparel, it's disturbing. I wouldn't be surprised if we receive one more earnings guide down from Target next week, and then the stock begins to recover.
Keep an eye on this one.
It's been a horrible news year for the restaurant chain Darden (DRI) -- atrocious actually. The stock caught an upgrade this week amid optimism that the menu revamp at the Olive Garden chain will bring customers back. Be careful, however. I think this was a flawed upgrade. There is serious competition that will likely hinder Darden's return to relevance; I very much like the new menu initiatives at Applebee's, TGI Friday's and Red Lobster. Additionally, fast-food chains are pushing into healthy dinner food with an Italian flair, such as Pizza Hut with artisanal pizza, and Starbucks (SBUX) with its Evenings menu.
Abercrombie & Fitch
Shares of Abercrombie & Fitch (ANF) were hammered last week on less-than-cheery earnings guidance. I am telling you, there could be an analyst on the Street trying to play stock stud by issuing an upgrade here, citing cost savings from a restructuring plan and private equity buyout potential. Buyer beware here, as well.
I think Abercrombie & Fitch is a fundamentally flawed entity, operating giant international flagships that suck up huge rent payments and having to deal with the lightening-quick supply chains of Forever 21, H&M and Zara. Quite frankly, despite three years of aggressive store closures in the U.S., I believe the company has to consider jettisoning the kids division, and closing more domestic Abercrombie & Fitch and Hollister stores in order to more quickly get merchandise to market.
And those efforts would pummel the stock.
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At the time of publication, Sozzi and his firm had no positions in any of the securities mentioned.
Editor's Note: This article was originally published at 10:35 a.m. EST on Nov. 12.