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 ...
"Best." That's a bit strong to describe today's featured analyst, Cowen & Co. We're looking at Cowen because of its upgrade yesterday of CA (NYSE:CA) to outperform ... and I have to admit that at first glance, I'm looking askance.

You see, this investment banker doesn't win any awards for its 45% accuracy on stock picks. Sure, Cowen beats about three out of four investors in this game, so it's not absolutely horrible at this investing thing. While Cowen makes more than its fair share of mistakes ...

... the banker also makes picks that can only be termed "brilliant," a leap of faith that erases a multitude of prior stock sins:

So rather than "best," perhaps it's "best" just to call Cowen "halfway decent."

Similarly with Cowen's upgrade of CA. According to Cowen:

CA shares have approached what we calculate as the discounted value of the company's stable annuity contract portfolio...With more comfort around the stability of cash flows going forward, we believe shares at current levels (8x 2009 EV/FCFF) have little downside. ... There is [10% to 30%] potential upside from additional cost-cutting efforts and improvements in sales productivity as reps sell new products into the installed base. ... depending on the degree of success of the above initiatives.

EV/FCFF?
The analyst is referring to "enterprise value divided by the free cash flow to the firm." And the point Cowen is trying to make is this: At first glance, CA looks awfully expensive. The IT specialist carries a P/E of 18, while its projected growth rate, according to the dozen or so analysts who follow it, is just 13%.

The resulting PEG ratio of 1.4 doesn't exactly look like a bargain, but Cowen is saying that free cash flow at CA outweighs net earnings as reported under GAAP by so much that the company is actually cheaper than its stock at first appears. I agree.

While I don't use forward earnings in valuing stocks myself (here's why), based on the free cash flow that we know CA generated over the past year, the stock does look pretty reasonably priced to me. Trailing free cash flow amounts to $1.05 billion at CA. Divide that into CA's market cap, or its enterprise value -- take your pick, in this case they're basically identical -- and you get a price-to-free cash flow ratio of about 9.9.

Foolish takeaway
To me, that looks like a decent discount to intrinsic value. Not a screaming buy. Just decent -- which is perhaps the best we should hope for from an analyst like Cowen.

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