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 ...
Two of the best stock pickers on the Street combined to deliver a one-two punch to Hershey (NYSE: HSY  ) yesterday, knocking the shares down more than 9%. Citigroup led with a right jab, downgrading the shares from buy to hold. Then Stifel Nicolaus followed with a left cross in the form of a sell rating.

And the worst news of all: They're probably right.

The reasoning
Our two raters today approach the question of "selling Hershey" from two very different directions. Stifel frames the argument as a simple matter of valuation, criticizing: "the recent run-up in the stock price accompanied by [recent] heavy option activity" and predicting "share price weakness ahead."

Citigroup arrives at a similar conclusion, but goes the operational route, arguing: "We believe [Hershey] still has issues that need fixing and see the stock price as reflecting the good news that came out of the 2Q08 earnings report. ... [V]isibility on [acceleration of growth] is limited and risk remains that it does not materialize."

Citi then proceeded to name four companies that it thinks are better choices: ConAgra (NYSE: CAG  ) , General Mills (NYSE: GIS  ) , Kellogg, and Heinz (NYSE: HNZ  ) . (Meanwhile, Heinz's chief executive voiced the opinion last week that Campbell Soup (NYSE: CPB  ) is looking mighty tasty right about now.)

So there's lots of love going around the food sector right now. Sadly, no one's got any kisses for Hershey.

The raters
Should investors care what Citi and Stifel say? Actually, yes you should care, because when it comes to picking stocks, these two bankers are top of the heap. In our tracking of them in CAPS, each firm is more often right than wrong on its recommendations. Each ranks well within the top 20% of investors as calculated by CAPS; Stifel bears the title of "Wall Street's Best," ranking 14th out of 170 professional stock pickers tracked by CAPS.

Foolish takeaway
As much as I love my Reese's, I'm afraid I'm going to have to side with the analysts on this one. Hershey's prospects, plus Hershey's stock price, are two mediocre tastes that taste just lousy together. Here's why:

Hershey is following the lead of consumer staples companies like Kraft (NYSE: KFT  ) and Procter & Gamble (NYSE: PG  ) by raising prices. But even Hershey doesn't expect this move to boost sales. Higher prices increase revenue per unit sold, of course, but they also make goods less affordable, reducing the number of units sold. As a result, I'm with Citi in my skepticism that growth will "materialize" here.

And as for Stifel's valuation concerns, even after yesterday's sell-off, Hershey trades for 39 times trailing earnings. Sure, the price-to-free cash flow ratio is a more downmarket 15. But considering that most analysts don't believe Hershey can manage more than 5.5% annual earnings growth long term, even that metric gives you no margin of safety whatsoever. Simply put, the shares are expensive, and bound to get cheaper.

Kraft Foods and H.J. Heinz are both Motley Fool Income Investor recommendations. This sweet, market-beating newsletter can be yours free for 30 days.

Fool contributor Rich Smith does not own shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 493 out of more than 115,000 players. The Fool has a disclosure policy.


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