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.

Bernstein's two-fer
Investors reading Bernstein's opinion on EMC (NYSE: EMC) yesterday may have gotten more than they bargained for -- and certainly more than they wanted to hear. In the process of downgrading the information-storage specialist to hold, Bernstein inflicted significant collateral damage on EMC's subsidiary, VMware (NYSE: VMW). In fact, the more you study the opinion, the more it looks as though VMware is the stock that Bernstein really hates, and that downgrading EMC was more of an afterthought.

Bernstein cited three key arguments against buying EMC today:

• When you credit it with the value of its 86% stake in VMware, EMC proper looks cheap. However, if EMC were ever to try to "monetize" VMware by spinning off its remaining shares, "the large increase in its float [from the influx of shares currently held by EMC] could pressure the stock."
• Moreover, increasing competition from Microsoft (Nasdaq: MSFT) and Citrix could compress margins at VMware. Only after that happens, Bernstein fears, will we realize just how overpriced VMware's stock really was -- and by extension, how EMC was not quite as cheap as it seemed.
• Finally, Bernstein warns that IT spending could weaken in a recession (um, duh) and that EMC relies heavily on sales to the financial sector, which is looking especially shaky these days (double-duh.)

Let's divide these concerns into their two component parts and address them separately.

Spinoff risk
As far as the spinoff risk goes, EMC CEO Joseph Tucci allayed fears yesterday, when he confided that EMC has "absolutely no interest" in spinning off its remaining 86% interest in VMware. The worry, though, would be that by keeping VMware stock mostly in house, he's keeping VMware's true worth secret, and holding the question of how much value VMware adds to EMC up in the air.

Recession risk
Seems Microsoft plays the part of bogeyman to every tech company. But just how good is Bernstein at calling tech trends? Is it right in gauging the magnitude of the slowdown in tech spending generally, and in the financial sector in particular? Reviewing a few of Bernstein's past picks in each industry may give us a clue:

Company	Bernstein Said:	CAPS Says (5 Max):	Bernstein's Pick Beating (Lagging) S&P by:
Intel (Nasdaq: INTC)	Outperform	****	(18 points)
Sun Microsystems (Nasdaq: JAVA)	Underperform	***	43 points
Merrill Lynch (NYSE: MER)	Outperform	*	(43 points)
US Bancorp (NYSE: USB)	Outperform	****	12 points

So as it turns out, Bernstein is pretty hit-or-miss in both tech and banking. And the examples above tally up well with Bernstein's overall performance on CAPS. The analyst scores just a 60.86 CAPS rating and gets only about 52% of its picks right.

But although Bernstein isn't a particularly great analyst, I honestly don't think you need to be great to get this call right -- and I agree with the analyst that EMC is at least moderately overpriced today. To my mind, the stock's price-to-earnings ratio of 23 suggests as much, and its price-to-free cash flow ratio of 16 confirms it. Neither number compares favorably with the 13% annual profits growth that analysts project for the company.

Similarly with VMware -- and even more so. The company carries a nosebleed-inducing, triple-digit P/E, and a P/FCF ratio that's not much better. Even a projected 46% earnings growth rate fails to justify those multiples.

Foolish takeaway
Whether Bernstein is right or wrong about the falloff in tech spending, competition from Microsoft squeezing margins, and the effect of a full-blown VMware spinoff, the numbers are clear: EMC is overpriced, and VMware's overvaluation is a contributing factor.