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 ...
Citigroup executed a clean 180-degree turn on Pacific Sunwear (Nasdaq: PSUN) on Monday (Citi's pretty agile for a bank of its bulk), dropping its rating all the way from "buy" to "sell." The downgrade helped slice 4% off of PacSun's market cap on a day with no other news of note for the stock.

What's got Citi's Billabongs in a bunch? According to the analyst, PacSun will face "continued gross margin pressure on poor overall topline." Further down the income statement, Citi sees a 3% to 7% rise in selling, general, and administrative expenses adding to PacSun's margin pressure. Combined with same-store sales growth that Citi puts at about 4%, all of this could add up to declining earnings at the retailer. 

In contrast, the Fool's own Rich Duprey recently praised PacSun for regaining its balance and urged investors to hold off on packing it in on this Motley Fool Stock Advisor recommendation. So whom are we to believe, investors? Obviously, the ordinary investor's instinct will be to favor the megabank over one lone Fool crying in the wilderness. But is that wise? Or should I say, Foolish?

Let's go to the tape
After all, while Citigroup is a relatively well-respected name on the Street, it doesn't fare well by objective metrics. Sure, Citi ranks near the top 10% of investors as scored by CAPS, but it does so in spite of -- not because of -- the accuracy of its predictions. In general, Citi gets just 51% of its picks right. For example:
 

Company	Citi Said:	CAPS Says (5 max):	Citi's Pick Beating S&P by:
Alcoa (NYSE: AA)	Outperform	****	36 points
Ann Taylor (NYSE: ANN)	Outperform	*	22 points
Wal-Mart (NYSE: WMT)	Outperform	***	12 points

Of course, expertise in metals-maker Alcoa may not translate to an ability to pick action-sport retailers like PacSun. For that matter, I suspect Ann Taylor's and Wal-Mart's target markets don't share a lot of overlap with PacSun's, either. So let's look a little closer to home:

Company	Citi Said:	CAPS Says (5 max):	Citi's Pick Lagging S&P by:
Under Armour (NYSE: UA)	Outperform	***	23 points
VMware (NYSE: VMW)	Outperform	***	10 points
Dick's Sporting Goods (NYSE: DKS)	Outperform	****	6 points

Oops. How'd VMware get in there? There's a big difference between -wear and -ware. Gotta monitor my spellchecker more carefully. However, Under Armour and Dick's seem much better aligned with PacSun's action sports orientation. Unfortunately, this table is listing the stocks where Citi's gone wrong -- and Citi's performance on these two stocks doesn't seem to merit a "wave."

In spite of Citi's lackluster retail record, though, might it be right this time? I very much fear that it is. Reviewing PacSun's numbers, what I see here is a company that lost money last year, while generating only a trickle of free cash flow. That's compared with the year before, when PacSun made money ... while generating only a trickle of free cash flow. And both of the past two years are compared with years past, when PacSun earned beaucoup bucks and generated mongo moola.

Foolish takeaway
With PacSun lacking the profits necessary to generate a meaningful P/E ratio, I note that the stock does at least sell for a tempting P/S ratio -- about 0.6 times trailing sales. As cheap as that sounds, though, consider that most apparel stores sell for similar multiples right now, so PacSun is really nothing special in this regard.

Finally, PacSun earns below-average operating profits on its revenue -- meaning that at today's price, you're being asked to pay a premium price for a retailer with subpar profitability. My advice: Stay away from this one, Fools. PacSun's a wipeout.