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 did.

But in "This Just In," we don't simply tell you what the analysts said. We 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 can track the long-term performance of Wall Street's best and brightest -- and worst and sorriest, too.

Ouch. That was unpleasant.
Motley Fool Stock Advisor recommendation Healthways (Nasdaq: HWAY) ripped the bandage off its guidance yesterday, warning that the loss of two contracts it had expected to ink this year would reduce expected profits by about 16%. Investors sold off the stock by 30%, making Healthways one of the absolute worst-performing stocks on any market yesterday.

But taking a look at Healthways' new and improved (?) price, one Wall Street banker sees a bargain. This morning, Stifel Nicolaus upgraded the shares from hold to buy, arguing that investors overreacted to the earnings warning, and said, "Healthways serves an integral role within the health-care system that is unlikely to be disintermediated on a broad scale."

Huh?
Wow. "Disintermediated"? Stifel sure sounds smart. Problem is, when it comes to predicting whether a stock will outperform or underperform the market, these guys aren't much more accurate than a coin toss. Stifel boasts an impressive CAPS rating of 87.15, but the analyst gets only a hair over half of its guesses correct. A few examples drawn from the health-care field:

Of course, by definition, a 50% record for accuracy means Stifel also gets some picks right. Here are a few of its better guesses:

How can Stifel parlay a 50/50 record for accuracy into a CAPS ranking in the top 15% of investors? On those occasions when Stifel is right, there's generally a bit of upside to its guesses. In my view, that's the case with today's endorsement of Healthways -- a 30% drop creates its own opportunity for a bounce back. Here's why:

The way I read Healthways' earnings warning, management aimed to take a big bath yesterday. In walking back its earnings guidance, the company not only factored in the absence of two expected contracts, but tossed into the bath a couple of kitchen sinks, namely:

"A now expected net cost impact of the MHS pilots of approximately $0.22 per diluted share" and "the previously expected net cost impact of the Company's move to its new headquarters and of the Company's international business."

The idea here is to get all the bad news out there, get it all factored into a depressed stock price. Now the stock can move higher on nothing but good news going forward.

My guess is that Stifel saw and recognized this gambit, and that's why it wasn't fazed by the news. And in fact, one of Stifel's more intelligible comments supports this view: "Revenue and earnings for 2008 appear conservative and suggest limited downside risk from current levels." Translation: Healthways just took a big bath, and should now be squeaky clean.

Foolish takeaway
Its mixed record notwithstanding, I'm with Stifel on this one. When I look at Healthways, I see a stock selling for 14 times its trailing free cash flow, which analysts on average expect to grow at nearly 22% per year over the next five years. And even if those expectations come down a bit after yesterday's earnings warning, the stock still looks cheap to me. So to Healthway bears I say: "Stick that in your pipe and disintermediate it."