This Just In: Upgrades and Downgrades

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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 worst and sorriest, too.

And speaking of the best ...
Shares of ADP (NYSE: ADP) and Paychex (Nasdaq: PAYX) are tumbling today after Banc of America Securities, the investment banking arm of Bank of America, shoved both payroll processors off the cliff. Worrying that a weaker economy will cause smaller businesses to cut spending on payroll processing services, B of A took an ax to its "buy" ratings on both stocks, downgrading each to "neutral."

And yet, B of A made a point of praising both companies' business models, and predicting that whatever the economy does, both ADP and Paychex will continue to grow their profits. So which is it, B of A? Are the companies overpriced stocks that will underperform the rest of the market, or great businesses that will survive a bum economy?

It's both
The way I see it, those two conclusions aren't mutually exclusive. You see, at their current prices, and based on current analyst estimates, both ADP and Paychex look overpriced relative to their prospects. ADP trades for 19 times earnings and is expected to grow its profits at about 14% per year long term; Paychex costs more (23 times earnings), and is expected to grow faster (at 15%). Thus, neither stock passes a basic PEG test on valuation.

And yet, you'll notice that while neither stock's price offers an attractive price relative to growth, both are expected to grow -- and 14% to 15% growth through a recession and out to the other side is nothing to be ashamed of. On the contrary, it's downright respectable.

I guess the real question here, then, is whether B of A is correctly calling a weakening economy in the first place. Based on the banker's record, I suspect it is. Over on CAPS, where we've monitored B of A's record for well over a year now, this analyst maintains a CAPS rating in the top 10% of players, and it gets a majority of its picks right across a broad swath of industries. For example:

Company	B of A Said:	CAPS Says (5 max):	B of A's Pick Beating S&P by:
Apple	Outperform	***	47 points
Potash (NYSE: POT)	Outperform	****	47 points
McDonald's (NYSE: MCD)	Outperform	****	26 points

To my mind, this suggests an ability to identify economic trends and to pick the stocks that will benefit from them. Of course, even a good analyst makes bad calls from time to time. For example, B of A has been particularly bad at charting the course of its fellow megabanks:

Company	B of A Said:	CAPS Says (5 max):	B of A's Pick Losing to S&P by:
Merrill Lynch (NYSE: MER)	Outperform	**	36 points
Morgan Stanley (NYSE: MS)	Outperform	**	27 points
Washington Mutual (NYSE: WM)	Underperform	**	20 points

Foolish takeaway
Basically, for me, the decision to buy, sell, or hold ADP and Paychex comes down to valuation. Based on their respective prices, and the general consensus among analysts about how fast they're likely to grow over the next five years, neither stock looks attractively priced to me today. Add in B of A's specific downgrades, and that just confirms what I'm already thinking.

In other words, I don't hate either stock. I'm just not enthusiastic about owning them.