This Just In: Upgrades and Downgrades

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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 worst...
Swiss banker UBS served up a pair of buy ratings yesterday, declaring that the shares of both McDonald's (NYSE: MCD) and Yum! Brands (NYSE: YUM) are USDA-approved, Grade-A "buys."

What do the two stocks have in common (other than the cholesterol)? Most obviously, both are purveyors of cheap eats. As the parent company of KFC, Yum! does good business serving up fried chicken parts. And Mickey D's $1 menu concept appears to have legs, too. Simply put, in an economy as bad as this one, a lot of people who might otherwise patronize richer fare will instead march under the golden arches or make "runs for the border" (pun not intended) to Taco Bell.

But the food's not the only great deal here. UBS also considers the stocks value propositions. Citing its own estimates of forward earnings, UBS says that McDonald's earnings (and share price) "could accelerate" next year. As for Yum!, UBS believes that "commodity deflation, momentum in Taco Bell US and KFC China, restructuring, and platform innovation" hold the "potential for meaningful EPS growth."

Let's go to the tape
Judging from UBS' record, you might want to think twice before taking its advice. Putting the lie to the myth of prudent Swiss banking, UBS actually gets more of its stock picks wrong than right, ranking in the bottom quartile of investors. I mean, just look at some of these calls:

Company	UBS Said:	CAPS Says:	UBS Pick Lagging S&P by:
Baidu.com (Nasdaq: BIDU)	Underperform	**	65 points
Starbucks (Nasdaq: SBUX)	Outperform	**	38 points
VMware (NYSE: VMW)	Outperform	***	31 points

Is UBS always wrong? Of course not. Multiply its record of 48% accuracy by the nearly 1,000 picks it's made over the past couple of years, and UBS has picked hundreds of winners. For example, some of its outperform ratings in the retail sector (often grouped together with restaurants, industrywise) have performed splendidly:

Company	UBS Said:	CAPS Says:	UBS Pick Beating S&P by:
BJ's Wholesale (NYSE: BJ)	Outperform	***	45 points
Kroger (NYSE: KR)	Outperform	***	40 points

Even more telling, UBS has done well with the twin subjects of today's column. Our CAPS archives reveal two previous outperform ratings on Yum! -- both of which beat the market's returns handily. We also have UBS recommending McDonald's back in April 2007 and -- happy news -- reiterating its buy call two more times, according to Briefing.com, before yesterday's cheer. That pick's now a 63-point McMarket Mangler.

So what's the verdict?
UBS's overall sad standing in the CAPS ranks notwithstanding, it has a sterling record on both Yum! Brands and McDonald's. So why do I disagree with its recommendations today?

Simply put, the price isn't right. Sure, on the surface, the numbers here look every bit as good as UBS paints them. Both stocks pay generous dividends -- 3.6% for McDonald's, and 3% for Yum! Valuationwise, Mickey D's is selling for 14.3-times trailing earnings, with long-term growth projected at nearly 11%. Yum! looks even, well, yummier, at a 13 P/E and 12% growth.

But flip over the Happy Meal for a moment, and take a gander at the "Nutrition Facts" printed on the bottom -- or in this case, the cash flow statement. Over the past year, McDonald's free cash flow amounts to just $3.6 billion, versus the $4.6 billion it reports as "profit" under GAAP. Yum!'s comes to just $615 million, versus nearly $1 billion in net earnings.

Foolish takeaway
Based on the cash flow information, McDonald's is selling for an enterprise value-to-free cash flow ratio of 20, and Yum! for an even more fattening 24 EV/FCF. Now, maybe UBS is right, and the firms will grow into their valuations, even as the global recession grows. For today, though, based on the numbers I see and the growth projections as they stand, neither stock looks like a particularly healthy investment.