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 track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

And speaking of the best ...
After zooming up 2.5% yesterday, UPS (NYSE: UPS  ) stock coasted up another fraction of a percent this morning. What's got investors so excited over the color Brown? You know the answer: It's yet another upgrade from bandwagon-pusher JPMorgan Chase.

Yesterday, we discussed JP's decision to boost General Electric (NYSE: GE  ) stock on the theory that it was the "last of the low-expectations plays" -- a series of erstwhile unloved companies that investors have briskly resumed buying once they realize these businesses won't suddenly go "poof!" Well, now we learn that GE was actually just the next-to-last in line for that group. Because as it turns out, many of the same reasons why JP liked GE apply to UPS as well:

  • "Catch-up opportunity is meaningful." Based on 2009 YTD performance, UPS has underperformed its peers in recent months, lagging "80% of S&P 500 Industrials."
  • The company is misunderstood as a defensive transport name with less "operating leverage" than its peers. This misperception should boost the stock when the economy picks up.
  • JP believes that parcel/express volumes will gradually increase, ultimately helping UPS.
  • And, well, after seeing so many other disliked stocks zoom once investor sentiment turned in their favor, JP sees no reason why the trend won't work for UPS as well.

But is JPMorgan right?

Let's go to the tape
Statistically speaking, JP probably is right about UPS. While this analyst may be better known for its recommendations in the high-profile tech and financial sectors -- picking MasterCard (NYSE: MA  ) two years ago for a clean 100% profit, or Motorola (NYSE: MOT  ) earlier this year for a respectable 85% pickup -- its record in the twin industries of Road and Rail and Air Freight and Logistics looks even better:

Stock

JP Says:

CAPS says:

JP's Picks Beating (Lagging) S&P By:

YRC Worldwide (Nasdaq: YRCW  )

Underperform

**

45 points

Expeditors International

Outperform

****

17 points

FedEx (NYSE: FDX  )

Outperform

***

<1 point (two picks)

Norfolk Southern (NYSE: NSC  )

Outperform

****

(9 points) (two picks)

In fact, across the two industries, JP Morgan has a great record of success -- 66% accuracy on its multiple recommendations. Suffice it to say that, despite occasionally wandering off-track and "pulling a Norfolk Southern," this analyst retains a generally firm grasp of the concept of moving things from Point A to Point P(rofit).

All aboard!
And I have to say, Fools, is that the more I look at UPS today, the more I think JP's getting it right.

Now, I know some of you will be put off by UPS's high-seeming P/E ratio. And yes, 27 times earnings does seem a bit steep of a price to pay for a company that most analysts don't think will grow faster than 8% per year over the next five years. But by focusing on the P/E, you run the risk of missing two key data points:

  • First, UPS is a whole lot more profitable than meets the eye. While its reported earnings amounted to $2.1 billion over the last 12 months, the company actually generated free cash flow far in excess of that -- $4.6 billion. So valued on its free cash, this stock is selling for a much more reasonable-looking valuation ratio -- 12 times free cash.
  • Second, don't forget the dividend. While archrival FedEx flies high and light at a puny 0.6% yield, UPS delivers a truckload of cash to its shareholders -- a 3.3% dividend yield.

Foolish takeaway
Despite the somewhat anemic growth expectations voiced by most analysts, I believe that these two factors combine to justify owning the stock at today's prices. As for actually going out and buying more UPS shares, though?

Well, for that, you need to have faith that JPMorgan is right about the possibility of UPS delivering upside surprises on the profit front. JP argues that if UPS lost six full percentage points of operating margin between 2007 and 2009 because of revenue declines, then logically, a revival of the economy -- and of UPS's revenue -- should restore the lost profit margins just as quickly.

Judging from its record on past picks in the industry, I think that's a good bet to make.

FedEx is a Motley Fool Stock Advisor pick. United Parcel Service is a Motley Fool Income Investor selection.

Fool contributor Rich Smith does not own shares of any company named above. You can find him on CAPS, publicly pontificating about stuff he does understand under the handle TMFDitty, where he's currently ranked No. 618 out of more than 140,000 members. The Motley Fool has a disclosure policy.


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