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." Always a relative term, it's becoming ever relative-r on Wall Street, as such storied names as Citigroup, Lehman Brothers, and even JPMorgan Chase develop CAPS reputations in line with their rapidly evaporating market caps. A bit to the west of the carnage, though, St. Louis-based Stifel Nicolaus is managing to keep its rep intact -- and that's good news for Netflix (Nasdaq: NFLX  ) investors, because yesterday Stifel gave its stock the thumbs-up.

Stifel started the week off right with an upgrade of Netflix to "buy." Quoth the analyst: "In the current economy ... Netflix value-oriented offering stands out to us as a compelling alternative to more expensive entertainment alternatives." Stifel then proceeded to state the blindingly obvious -- renting a DVD from Netflix is cheaper than taking the family out to the local movieplex, and way cheaper than a night at the opera -- before concluding that compared with the alternatives, Netflix offers "relative value" to cash-strapped consumers.

Um, duh
Although it's tempting to mock the analyst for charging clients for this kind of advice, I won't. After all, Stifel has "reached" with its buy recs often enough in the past, resulting in such abject failures as:

Company

Stifel Said:

CAPS Says (Out of 5):

Stifel's Pick Lagging S&P by:

American International Group (NYSE: AIG  )

Outperform

**

56 points

XL Capital  (NYSE: XL  )

Outperform

*

46 points

US Bancorp  (NYSE: USB  )

Underperform

****

29 points

As a result, although Stifel currently outperforms better than 87% of investors tracked by CAPS, it does so not because of, but in spite of, a record of getting slightly more than half of its stock picks wrong. So perhaps the duh-scretion is the better part of valor in this market. Simply put, there's a lot to be said for sticking to conservative value calls.

Such as Netflix
I like the conservatism reflected in yesterday's Netflix pick. Reviewing the financials, Stifel observes that Netflix has $250 million in cash and will generate $65 million in free cash flow this year and then $75 million next year.

These numbers may surprise folks who thought Netflix generated a whole lot more cash than $65 million, of course. But four years ago, in a column titled "Free Cash Flow Illusions," I explained the correct method to calculate this company's free cash flow. The trick is remembering to include the cost of building the DVD library as a capital expense. Stifel takes that same approach in working its own FCF number, which precisely matches the $65 million I see Netflix having generated over the past 12 months.

Looked at this way, Netflix is currently trading for an enterprise value-to-free cash flow ratio of 14. To me, this suggests that if Netflix can achieve the 15% FCF growth Stifel foresees next year, the stock is, at worst, reasonably priced and, at best, cheap. And if Netflix can maintain such growth over the long term -- or even grow into the nearly 18% earnings rate that most analysts project for it -- the stock could well be dirt cheap.

Foolish minds think alike
It gives me a case of the warm fuzzies to see a "real" investor like Stifel validating my valuations. But the fact that I agree with the valuation isn't the only reason to like Stifel's Netflix pick. While Stifel's made some lousy picks in the financial services sphere (see above), this banker has done well in the entertainment bailiwick:

Company

Stifel Said (Out of 5):

CAPS Says:

Stifel's Pick Beating S&P by:

DIRECTV Group (Nasdaq: DTV  )

Outperform

***

22 points

Amazon.com  (Nasdaq: AMZN  )

Outperform

**

5 points

Amazon and DirecTV have two things in common: They're Netflix competitors, and they're both inhabitants of Stifel's "wins" column. To me, this suggests that the analyst has a good feel for such stocks generally, in addition to being right on Netflix's valuation in particular. Of course, I'd feel better if it had also made a correct call on Blockbuster (NYSE: BBI  ) , but it hasn't made any call on that company.

Foolish takeaway
Stifel may be no genius, but it's a halfway decent stock picker. Fortunately, that's all it takes to know that Netflix is a buy.

Fool contributor Rich Smith owns no shares of any company named above. You can find him on CAPS, pontificating under the handle TMFDitty, where he's ranked No. 505 out of more than 120,000 members.

US Bancorp and JPMorgan Chase are Income Investor selections. Netflix and Amazon are Motley Fool Stock Advisor recommendations. The Fool has a disclosure policy.


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