This Just In: Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycles 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 ...
What is it with all the drag racing and stunt driving on Wall Street these days? First we saw Citigroup do a U-turn on General Motors (NYSE:GM), and then UBS flawlessly imitated the move. Citigroup followed up by executing the same maneuver on Sun Microsystems (NASDAQ:JAVA) this morning. Yanking hard on its emergency brake, Citigroup shifted from "sell" to "buy" on the server maker so fast it makes your head spin.

And man, are heads ever spinning in investor-land today. When a big name like Citigroup reverses itself so sharply, you'd ordinarily expect to see the upgraded company's shares soar. Instead, Sun's shares tumbled 8% this morning. It seems that after reading about Sun's lukewarm quarter, investors are left unconvinced by Citi's argument that

1. Layoffs and restructuring will allow Sun to reduce its operating expenses by $400 million over the next two years.
2. Development of a full line of Intel (NASDAQ:INTC)-based servers will spark a rise in sales.

But are we right to be skeptical?

Let's go to the tape
Judging from its record on CAPS, investors might want to put a bit more faith in Citi. Although its 94.64 rating doesn't earn it a place among Wall Street's best analysts in CAPS, the investment banker does get most (55%) of its predictions correct. For example:

But it's not right all the time. Far from it:

Foolish takeaway
When I look at Sun's stock, I'm more inclined to err on the side of caution than follow Citi's lead. The stock trades at 40 times trailing earnings, yet most analysts -- Citi excepted -- agree that it's unlikely to grow its profits much faster than 11% per year in the long term. The resulting 3.6 PEG ratio looks awfully expensive to me. And with free cash flow closely approximating net earnings last fiscal year, the price-to-free cash flow ratio doesn't look much cheaper.

The one caveat I'd add to my instinctive revulsion at Sun's valuation is this: The company generated significantly more operating cash flow in the just-ended fiscal first quarter than it did in last year's Q1. It did the same in the previous quarter, though not to the same extent. If Sun can continue this performance in quarters to come, then Citi's optimism will make a whole lot more sense. For the time being, though, I remain in "trust, but verify" mode on this stock.

Disagree? Feel free -- but please drop by Motley Fool CAPS and tell us why.