Thursday's Top Upgrades (and Downgrades)

This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense and which ones investors should act on. Today our headlines feature a positive rating for Xerox (XRX) and an upgrade for Brinker (EAT) . Meanwhile, on the bad news front...

Cheesecake Factory curdles
We might as well get the bad news out of the way first, and today, the bad news concerns Cheesecake Factory (CAKE) , which is the subject of a negative movement in price target from the Telsey Advisory Group.

This morning, Telsey sliced $3 off its price target for Cheesecake Factory, positing a $52 valuation on the stock. Optimists, however, will be quick to point out that even this lower price target implies about 12% upside to Cheesecake Factory shares, which currently sell for about $46 and change. But are the shares really worth even that much?

Only yesterday Cheesecake Factory reported its Q1 2014 earnings, and they came in at just $0.43 per share -- down year over year, and $0.06 short of analyst estimates. Revenues topped expectations, but were still up only 4% in comparison to last year's Q1 -- a far cry from the 14% long-term earnings growth rate that analysts are expecting the stock to produce. And indeed, even if Cheesecake Factory were producing its hoped-for 14% growth rate, it would be hard to argue that this would be fast enough growth to justify the 21-times-earnings multiple that Cheesecake Factory shares currently sell for.

Accordingly, Telsey's argument that the shares should fetch 12% more than today's share price is even harder to swallow.

EAT out?
Continuing today's eat-out theme, we turn next to Brinker International, which owns the Chili's and Maggiano's Little Italy restaurant chains. In contrast to Cheesecake, whose stock is sinking in Thursday trading, Brinker shares are enjoying a boost from yesterday's fiscal Q3 earnings report, which featured $0.84 in per-share profit -- a penny ahead of estimates, despite revenues that fell a bit short of the mark.

This strong performance prompted an upgrade to "buy" at the hands of analysts at Miller Tabak today, which says the stock should hit $58 within a year. Happily, this argument has a bit more to it.

Priced at 19.5 times trailing earnings, Brinker shares may look expensive for their projected 13% growth rate and 1.9% dividend yield. But Brinker generates strong free cash flow from its business -- $198 million in cash profits over the past year, or about 15% more than the company is allowed to claim as "net income" under GAAP accounting rules. As a result, Brinker's price-to-free cash flow ratio is a more appetizing 16.9 -- almost cheap enough to consider buying based on the company's projected growth rate and dividend yield.

Would I go so far as to call the stock a buy, as Miller Tabak does? No. But I will say the stock looks a whole lot cheaper than that of Cheesecake Factory.

Double down on Xerox?
Last but not least, we switch gears to consider a positive rating that just came out on old-tech stalwart Xerox Corporation. Following Xerox's earnings beat Tuesday ($0.27 per share, versus $0.24 expected), broker Susquehanna International initiated coverage of the stock with a "positive" rating this morning, and a $14 price target.

Which is actually kind of curious. Sure, Xerox "beat earnings" for Q1. But ordinarily (if perversely), the stock market tends to discount a company's accomplishments in favor of the promises it makes about future performance -- and Xerox's promises this week weren't particularly good. Management guided investors to expect at most $0.27 per share in profit for the current second fiscal quarter of the year, versus analysts' expected $0.28. And even looking farther out to year-end, Xerox declined to promise that it would hit analysts' hoped-for $1.13 in per-share profit, saying only that it expected profits to range between $1.07 and $1.13 per share.

On one hand, that's not horrible news. $1.13 per share would give Xerox about a 10.6 P/E ratio at today's prices, while $1.07 would only push that P/E up to 11.2 -- both numbers cheaper than the 12.4-times earnings valuation that the shares currently carry. On the other hand, though, none of these valuations look particularly attractive in light of Xerox's projected 4% long-term earnings growth rate.

What may finally tip the scales in Xerox's favor, though, is the fact that Xerox is generating a whole lot more cash profit than its income statement lets on -- $2.4 billion in positive free cash flow, or more than twice reported net income. Weighed against the company's $14.2 billion market cap, that works out to a price-to-free cash flow ratio of less than 6. And that seems to me cheap enough a price to pay, even for a company growing at only 4%, so long as Xerox maintains its 2.2% dividend yield.

Long story short, Susquehanna sees the valuation on this one as a "positive" -- and I do, too.

Rich Smith has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned, either.