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 ...
Yesterday, Piper Jaffray upgraded the stock of warehouse wholesaler Costco (NASDAQ:COST) from "market perform" to "outperform." An everyday occurrence in the fickle world of analyst ratings revisions, no doubt -- but the real story here looks to be the roundabout means Piper traveled to reach this end. Piper begins its upgrade thesis with an acknowledgement that, trading for 21 times the profits it's expected to earn in 2008, Costco looks expensive. (OK, so let's move on to look at another stock, then ... What's that? You want to recommend it anyway? Well, I hope you've got good reason.)

Finding Costco's PEG of 1.6 too pricey, Piper then set to searching for another peg to hang its upgrade on -- and found two. First, the analyst decided that the revenue stream of Costco's 48,000 club members, each anteing up $55 every year in dues, was worth $53 a share. Second, Piper guesstimated that the land values of Costco's real estate -- and in particular, the stuff that's located in the superhot California real estate market -- were in reality about 50% higher than the $9.5 billion Costco ascribes to them in its books.

What's wrong with that logic?
If you're like me, and you read comments like these in the press, you get to wondering. Wondering things like: Aren't those membership dues part of the same profit stream that Piper says add up to a too-high earnings multiple? And about the real estate -- it seems there've been unscrupulous bankers issuing risky loans lately, fueling crazy real estate appreciation in places like, um, California, and causing real estate prices to slide. What makes Piper think Costco's land is immune to this sequence of events?

Most individual investors lack access to the picky little details of analyst reports and are forced to make educated guesses about their logic based on isolated soundbites picked up by and reported in the media. Questions like the above become par for the course. So how's an investor to gauge whether an analyst knows what it's talking about, without seeing the whole report? At Motley Fool CAPS, we think we've found an answer: You can examine the analyst's record, which we track, and see whether the analyst has a history of making good picks.

In Piper's case, CAPS tells us that the firm sports an "All-Star" rating -- if only just barely -- thanks to picks like these:

That said, with its 86.42 rating, and its record of being right barely half the time (52%), Piper is anything but a star of the Wall Street world. Picks such as these haven't helped:

But does Piper know Costco, in particular? Apparently, it does. Reviewing the banker's record since reinitiating coverage on the stock in September 2004, we can see that its initial "outperform" rating beat the market's performance. Over the 17 months that Piper rated Costco a buy back then (before downgrading it to neutral), the stock outperformed the S&P by 11 points.

Long story short, I'm not terribly impressed with Piper's record as a stockpicker generally. Nor do I find its logic in recommending Costco now particularly convincing. But between Piper's having called Costco correctly in the past, and the Fool's own Tom Gardner having given Costco his stamp of approval as a recommendation of our Stock Advisor newsletter, I'm willing to give Piper the benefit of the doubt on this one. (Oh, and unlike Piper's analysis, our buy recommendation is available to anyone who wants to read it, yours free, along with a similarly free trial of the newsletter. Click here to learn more.)

So let's see: Piper likes Costco. Tom likes it. And between those two "buy" recs, I'm inclined to like it, too. Do you even need a fourth opinion? Well just in case you do, click on over to Motley Fool CAPS and see what the top-rated stock picker on Costco has to say about the company.

NYSE Euronext and Blue Nile are Rule Breakers recommendations. Blue Nile is also a Motley Fool Hidden Gems pick.  

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 178th out of more than 27,000 raters. The Fool has a disclosure policy.