Get to Know a Guru

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." In our recurring column, "This Just In," we cover the most headline-worthy upgrades and downgrades, testing the analysts' logic and examining their records to help you decide whether they're worth listening to at all.

In "Get to Know a Guru," we go another route. Here, we use upgrade and downgrade news as a springboard to introduce you to some of the lesser-known names in analyst-land. Up this week: Next Generation.

Profiles in punditry
An unfamiliar name (to me, at least) popped up on MSN Money's tally of analyst downgrades last week. A firm with the Trekkie-esque moniker "Next Generation" upgraded the stock of shoemeister DSW (NYSE: DSW  ) from "neutral" to "buy." Now, if you're wondering what business Captain Picard has picking stocks when he should be out fighting Borgs, you're not alone. Fortunately, that's the kind of question I aim to address in this column. So without further ado, let's ...

Get to know this guru
Forgive me my bluntness, but whatever marketing guru came up with the name "Next Generation" for this firm should get voted out of the guru club. Evocative as the name might be, it's been done to death on the Internet, and Google searches for the term are (according to my own unscientific, trial-and-error testing) about 95% more likely to turn up websites devoted to Trekking or gaming console updates than to equity research.

However, I was undeterred, and I eventually managed to track down the website for this stock picker. As it turns out, the firm's full name is "Next Generation Equity Research," and it's a small- to mid-cap stock shop focusing on the technology, consumer, energy, and health-care industries. Yet strangely for a firm that lists "energy" in its top four areas of interest, I could not find a single energy firm within its "research universe." Meanwhile, the firm appears to be devoting about 20% of its time to following machinery makers!

Based in Chicago, NextGen has been in business for at least three years (its website isn't precise on the question), has six analysts on staff, and covers approximately 60 companies.

Are these guys any good?
So much for the firm's biography. What we really want to know about is its resume. When NextGen speaks, should investors listen?

On average, yes, you can listen to NextGen -- just don't expect earth-shattering results when you do. The firm has a fine record for accuracy, getting 61% of its calls right. However, relative to its rivals on CAPS, NextGen's overall record is middling at best, with a CAPS rating that stands just shy of 65 (that's 12,461th place out of a field of 35,601 rated players, for those keeping score). A few of its notable successes include:

Next Generation Says:

CAPS Says (out of 5):

Next Generation's Pick Beating S&P By:

Seattle Genetics (Nasdaq: SGEN  )

Outperform

**

106 points

West Marine (Nasdaq: WMAR  )

Underperform

*

29 points

Stereotaxis (Nasdaq: STXS  )

Outperform

***

23 points

And now, a few less successful picks:

Next Generation Says:

CAPS Says:

Next Generation's Pick Lagging S&P by:

Coldwater Creek (Nasdaq: CWTR  )

Outperform

***

40 points

Dendreon (Nasdaq: DNDN  )

Outperform

**

55 points

Silicon Storage (Nasdaq: SSTI  )

Outperform

**

35 points

Separating the analyst from the analyzed
One year from now, will we find DSW's ticker prominently displayed in the first table above, or making a shamefaced appearance in the second? In a recent column, fellow Fool Steven Mallas took a look at DSW's just-released Q2 earnings and concluded the former. Steven cited the firm's sub-1.0 PEG, its top-line growth, and the favorable comps underlying that growth as arguments in the stock's favor.

Fools of a feather rarely fly together, however. For my part, I'm considerably less enthused about DSW. Although the firm failed to provide its shareholders with a copy of its cash flow statement for the quarter, judging from the last four quarterly statements that it has provided, I see a firm with less than $18 million in free cash flow, yet carrying a stock price 66 times that sum. Projected to grow earnings at 20% a year, the firm's PEG may be less than 1.0, but its price-to-free cash flow ratio is just too high.

Assume a well-stocked galoshes section will permit DSW to wade through the gathering economic storm without its sales and cash generation getting all wet. Even in that happy, but unlikely, scenario, my hunch is that DSW's price is too big a pair of shoes for its cash profitability to fill.

Disagree? Feel free -- just tell us why on CAPS. (There is no fee.)


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