Money Matters - Simplified

This Just In: Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." So you might think we'd be the last people to give virtual ink to such "news." And we would be -- if that were all we were doing.

But in "This Just In," we don't simply tell you what the analysts said. We'll also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we'll be tracking the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

This Just In: Upgrades and DowngradesGet original file (13KB)

And speaking of the best ...
Google (Nasdaq: GOOG) shares joined the rout on Wall Street yesterday, spurred by a downgrade to "source of funds" from a virtual Wall Street unknown. (For those unsure of the meaning, "source of funds" is a newish euphemism on the Street, translating roughly as "sell this garbage and put your cash to better use elsewhere.")

The analyst downgrading Google, San Francisco-based and London-owned ThinkEquity, observes that with Google now up 27% over the past three weeks, the shares are "currently reflecting a [second half of] 2009 recovery that we believe is unlikely to materialize."

According to ThinkEquity (TE): "the fundamental outlook for online advertising... continues to worsen." TE believes we're currently just four quarters into a "12-quarter media recession" that could hinder revenue growth at Google. The analyst predicts we'll see less than 4% year-over-year growth this year -- or less than half what the rest of Wall Street expects. (If it's correct, media conglomerates like Time Warner (NYSE: TWX) or News Corp. (Nasdaq: NWS) could be in for a rough ride as well.) But is TE correct?

Let's go to the tape
The analyst doesn't have the longest record on CAPS, but what we've seen so far suggests that yes, ThinkEquity has a good mind for online media. Alongside such out-of-sector stocks as SunPower  (Nasdaq: SPWRA) and InterMune  (Nasdaq: ITMN), the analyst has buy ratings on Yahoo! (Google's nemesis) and Blue Nile (not media, but a fair proxy for the Internet business world):

 

TE says:

CAPS says:

TE's Pick Beating (Lagging) S&P by:

Yahoo! (Nasdaq: YHOO)

Outperform

**

8 points

Blue Nile (Nasdaq: NILE)

Outperform

**

14 points

SunPower 

Outperform

***

18 points

Intermune

Outperform

*

59 points

And overall (and reiterating the caveat about the analyst's relatively short track record) ThinkEquity looks to be one of the better analysts on Wall Street so far. Most of the recommendations it makes, it makes right, and on average, the analyst is outperforming the S&P 500 by better than 7 percentage points per pick. That's good enough to rank ThinkEquity in the top quintile of investors tracked by CAPS.

Crunching the numbers
Personally, I'm not ready to run out and short Google just on ThinkEquity's say-so. Why not? Couple of reasons:

First, TE didn't quite tell us to sell Google at all. According to the analyst, when it labels a stock "source of funds," that only equals the "neutral" rating more often used in everyday Wall Street-speak. (Although for the life of me, I still can't figure how you can get "funds" out of a stock without selling it, any more than you can "accumulate" a stock -- TE's previous rating on Google -- without paying for it.) Regardless, the fact remains that TE says it doesn't really want you to sell Google -- just not buy it.

Second: After crunching the numbers, I tend to agree. Google generated $5.5 billion in free cash flow last year, which was considerably better than the $4.2 billion in net income it reported under GAAP. As such, the stock currently carries an enterprise value-to-free cash flow ratio of 17 -- which looks reasonable in light of analysts' predicted 20% long-term growth rate. Much more reasonable than the stock's 26 P/E might lead you to believe, in any case.

Copyright © 2008 Universal Press Syndicate.