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.

And speaking of the best ...
On Friday, Pennsylvanian portfolio powerhouse Susquehanna Financial upgraded the stocks of both Carnival (NYSE:CCL) and smaller rival Royal Caribbean (NYSE:RCL) from "neutral" to "positive." While admitting that it finds both companies' financials "unspectacular," Susquehanna nonetheless thinks the stocks have become simply "too cheap not to own."

Really? Too cheap? At first glance, Susquehanna seems to have a point. Trading for a trailing P/E of 16 and projected to grow earnings at 15% over the next five years, Carnival does look reasonably priced. Likewise Royal Caribbean, with its 14 P/E and 12% projected growth rate. A simple PEG analysis shows that both firms are trading very close to (yet not below) the magical 1-to-1 ratio of P/E to growth.

On the other hand, when we look past the surface GAAP numbers and evaluate the companies based on their ability to generate real cash profits, neither firm looks particularly "cheap." Carnival's $1.2 billion in trailing free cash flow amounts to just half its reported GAAP earnings, making the firm look decidedly pricey at 32 times free cash flow. Viewed from that perspective, Royal Caribbean seems even less of a bargain.

Let's go to the tape
I have to admit, after seeing these cash flow figures, I'm feeling pretty dubious about Susquehanna's statement. But before concluding the firm's maritime upgrades are all wet, let's check out its record on CAPS -- maybe Susquehanna has a history of finding value where others (such as yours Fool-y) can't?

... And then again, maybe not. According to CAPS, Susquehanna is one of the weaker players on "Wall Street" (actually, the firm is based a bit to the south of that venerable boulevard). Its combined rating of 41.35 puts it in the bottom half of CAPS players, behind a good 13,900 other investors, both lay and professional. Perhaps worse, the firm's 47.14% rate of pick accuracy shows that Susquehanna is more often wrong about its recommendations than right.

Referring to its past list of misguided calls, we find:

Yet Susquehanna's had some winners, too -- occasionally, brilliant ones.

On balance, though, I suspect that investors are better off ignoring Susquehanna's ratings this time around -- or perhaps even using them as a contrarian indicator. You see, the last time the firm took a positive position on Carnival and Royal Caribbean -- rating both of them "net positive" on the same day in May 2005, and then downgrading them to "neutral" 10 months later -- the two stocks proceeded to underperform the S&P 500 by about 13 points each.

I don't mean to sound harsh, but when I tally up the results:

• A blown call the last time it endorsed the two stocks,
• An overall record of underperformance, and
• Questionable arguments in favor of the stocks' undervaluation today ...

I simply see no reason to listen to Susquehanna when it endorses Carnival and Royal Caribbean.

Whom would I listen to? Funny you should ask. Over on CAPS, we've identified the two investors who have the highest scores for predicting the success of, respectively, Carnival and Royal Caribbean. With just a couple of clicks, you can learn their identities, and read their thoughts on the companies for free.

(By the way, if investing in travel and leisure is your thing, don't forget to claim your free 30-day trial of Motley Fool Rule Breakers, where you can read all about Rick Munarriz's idea for the sector, an exceptional stock that's outperformed the S&P 101% to 25% over the last couple of years. Just like playing CAPS, taking a trial is absolutely free.)

Fool contributor Rich Smith does not own shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked 17 out of nearly 24,000 raters. Activision is a Motley Fool Stock Advisor pick. The Fool has a disclosure policy.