Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
What to make of Dick's Sporting Goods (NYSE: DKS)?
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Yesterday, the big sporting goods retail chain reported results that can only be called mixed. Sales for the fiscal third quarter were up year over year, and profits beat estimates -- but were still down sharply from last year's Q3. It didn't take long for Dick's Sporting Goods stock to suffer from the news yesterday, but already this morning, the shares are rebounding and rising past where they stood ahead of earnings Monday.
Following the report, a slew of stock shops cut their price targets for Dick's. But one banker stood out from the crowd this morning and shouted, "Buy!" Here's what you need to know about that.
1. What Dick's Sporting Goods reported
Announcing its fiscal Q3 results Tuesday morning, Dick's advised that its sales grew 7.4% year over year to $1.94 billion, despite a 0.9% decline in same-store sales. Profits came in ahead of depressed expectations at $0.35 per diluted share, but nonetheless declined 20% year over year.
Commenting on the results, Dick's CEO Edward Stack blamed a "highly promotional environment" for the weak profits in Q3. Looking forward, he further warned that in fiscal 2018 the company is anticipating "continued gross margin pressure and approximately flat comp sales," resulting in earnings as much as 20% less than than what the company will earn this year.
2. How Wall Street reacted
Wall Street didn't like that at all. The prospect of seeing a 20% drop in earnings in 2018 sparked a series of cuts to Dick's price target on Wall Street.
At last report, StreetInsider.com had counted no fewer than nine separate analysts cutting their price targets on Dick's in response to the earnings warning. Here's a quick sampling of what they had to say:
- Dick's earnings 2018 outlook "falls well below estimates." (Stephens-- price target $24 a share, from $28)
- "Industry woes" are to blame for Dick's weak profits. (MKM Partners -- $25 price target, from $30)
- "Elevated investments" are adding cost, while "deeper promotions" are cutting into revenue. (Citigroup-- $28 target, from $30)
- And overall, the sales environment for sporting goods looks "challenging." (Merrill Lynch -- $30 target, from $35)
Across Wall Street, price targets are tumbling, and analysts are split. About half are revising their estimates to predict a Dick's stock price of $24 or $25 -- i.e., less than it costs today -- while half are still marginally optimistic, and still think Dick's can rise to hit $28 or $30.
3. JPMorgan: Odd man out
And then there's JPMorgan. Alone among analysts on Wall Street today, JPMorgan is taking heart from Dick's Tuesday report and upgrading the stock to overweight.
Why? JPMorgan argues that much like Best Buy in electronics, Dick's is positioned to remain the last bricks-and-mortar sporting goods store standing. According to the analyst, as more and more of Dick's competitors go out of business, the oversupply of sporting goods inventory will "clean up" around about the midpoint of next year, alleviating promotional pressures and allowing Dick's to begin raising prices again.
Perhaps most importantly, JPMorgan finds Dick's decision to cut its earnings guidance reassuring, because it sets investor expectations at a lower level, making it easier for Dick's to exceed them next time it reports earnings. This minimizes the risk of an earnings miss in early 2018 and sets up Dick's stock to outperform the market.
The most important thing: Is Dick's stock cheap enough to buy?
Is JPMorgan right about that? Let's take a look at a few numbers.
Currently, with a market capitalization of $2.8 billion and $298 million in trailing-12-month profits, Dick's stock looks cheap at a valuation of just 9.4 times earnings. Dick's debt position ($410 million more debt than cash on its balance sheet) raises the stock's valuation slightly, but not excessively, to a debt-adjusted price-to-earnings ratio of about 10.7.
That would be a fine valuation if Dick's Sporting Goods stock could be depended upon to grow at even a low-double-digit percentage rate over the long term. Unfortunately, what Dick's is telling us is that its earnings will not grow, but shrink next year. Even assuming that growth resumes in 2019 and beyond, analysts currently project no better than a 4% long-term earnings growth rate for Dick's stock.
Result: Despite its low P/E ratio, Dick's stock is still selling for PEG ratio of more than 2.
Much as I'd like to root for Dick's alongside JPMorgan today, I think that price is still too high to pay.
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