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.

Everybody hates EA
Judging from the cavalcade of downgrades on Wednesday, that's almost true. According to Briefing.com, five separate analysts downgraded gaming guru Electronic Arts (NASDAQ:ERTS) --  Pacific Growth, Wedbush Morgan, Piper Jaffray, Citigroup, and Banc of America Securities. And even then, we're understating the case. Not everybody reports rating changes to Briefing.com, and if you're a glutton for punishment and want to go looking for extra downgrades or negative comments, you won't have to search far.

Nor need you look far for the impetus for the downgrades. As fellow Fool Rick Munarriz described Wednesday, business looks mighty weak for EA right now. How weak remains unclear, but management says it will not be hitting its previously expressed targets, the floor on which was $1 a share in pro forma profit on at least $5 billion in revenue. Nor is EA the only 98-pound weakling in the gaming industry. GameStop (NYSE:GME) disappointed investors last month (around the same time as THQ was warning), and Sony (NYSE:SNE) is laying off staff, though not related to the PlayStation 3.

Let's go to the tape
Now, it's not all lousy news for EA shareholders. Often enough, when Wall Street rushes in a pack down one path, there turns out to be a cliff at the end of it. And (switching metaphors for a moment), if there's a bright light at the end of this tunnel of downgrades, it may be the fact that most of the analysts named above aren't exactly shining lights of brilliance. Four of the five rank in the, ahem, bottom 20% of investors tracked by CAPS.

Or is that light a freight train? Looking closer, at least one analyst in this pack does have a record to be proud of: Banc of America Securities. This past quarter alone, BofA has made bright calls such as:

Adding to its win list, if you dig through BofA's ratings archives a bit, you'll find the analyst racking up 13 points of outperformance the last time it recommended THQ, and 58 points more on a still-active recommendation of Activision Blizzard (NASDAQ:ATVI). Clearly, this is one banker who knows which side of the PS3 is the shootin' end.

On balance, I'm willing to trust BofA's judgment on this one -- and give its fellow travelers a pass for hopping aboard the "EA SUX" train. But I do so not just because I like BofA's record. I do it because to me, the case against EA is obvious.

Buy the numbers
Listen, I've been telling folks EA was overpriced for years. Since way back in October of 2005, in fact, when the stock was trading north of $55 -- more than three times today's price. And my opinion hasn't changed. Why? Because the company simply doesn't generate enough free cash flow -- and never has.

EA's cash from operations has dropped every year for the past five -- and this, in the middle of the huge wave of game-buying ushered in by the triple play of PS3, Xbox, and the Wii. Generating just $109 million in free cash flow over the past 12 months, EA sells for a bloated 51 times multiple to that. Nor does it find salvation in its P/E ratio -- because it's running at a loss right now, EA doesn't even have a P/E ratio.

Foolish takeaway
Not every analyst downgrading Electronic Arts on Wednesday was a genius. But with numbers like these, you don't have to be a genius to know that EA's probably no buy.