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 worst ...
What do you do when one of the worst stock pickers in the CAPS world takes a liking to one of your favorite stocks? The Foolish course of action might be to exclaim: "Uh-oh!" and reexamine the investment thesis. But that's decidedly not how investors are reacting to this morning's upgrade of Motley Fool Stock Advisor recommendation Axsys Technologies (NASDAQ:AXYS).

To the contrary, no sooner had Wall Street Wunderkind Morgan Keegan upgraded Axsys to "outperform" this morning, than investors leapt for joy, ran to open their online brokerage accounts, and began frantically clicking "buy" -- the stock's up 12% as of this writing. What explains the upgrade, and should you follow Morgan Keegan's advice? We'll look at both questions today.

First, the rationale
Basically, Morgan Keegan is doing a bit of winter ice fishing here -- bottom fishing, actually -- as the analyst cited Axsys' 36% fall the past two weeks as a key factor in upgrading the shares. Yet, muses the analyst: "We see no fundamental cause for this decline in value and remain optimistic about the company's near and long term prospects." The analyst mentioned that Axsys has less exposure to the commercial market than FLIR Systems, adding, "[W]e do not expect any significant delays in either company's government projects."

And now, a few words on the record
Interesting that Morgan Keegan should drag Axsys rival FLIR into this picture. Turns out, that stock is one of the analyst's success stories:

But those successes are only coming 45% of the time. As well as MK has performed on the picks named above, it's done even worse the times when it guessed wrong:

Over the course of 192 stock recommendations we're tracking for the analyst on CAPS, the average pick tends to lag its S&P 500 peers by a good two percentage points. Much as it pains me to say it -- I expect nothing different out of today's prediction. Here's why:

Putting Axsys under the lens
Has Axsys taken a tumble? No doubt. Lots of stocks have. But the simple fact that Axsys is now 40-odd percent cheap-er than it was at this year's high point does not make the stock "cheap," period.

From a P/E perspective, Axsys sells for 19.6 times earnings, and while that doesn't look unreasonable in light of analysts' expected 18.7% long-term earnings growth, it's still a pretty premium over the market's 16 times multiple. Moreover, this P/E is based on Axsys' reported net earnings under GAAP.

Turns out, however, that these earnings aren't well supported by free cash flow -- because there isn't any. In fact, even as it reported $25 million in net income over the past 12 months, Axsys burned more than $8 million in free cash -- nor have its net earnings measured up to free cash flow in any of the last five years.

Foolish takeaway
Ever since David Gardner tapped Axsys to enter the ranks of his market-thrashing side of the Motley Fool Stock Advisor portfolio, I've been a fan. High-tech optics in an age of unmanned aerial vehicles and advanced robotics. Cool! But today, my thanks go instead to underperforming analyst Morgan Keegan -- for reminding me to take a closer look and remember why I never bought into this stock.

Simply put: Axsys isn't as cheap as it looks, nor nearly as cheap as Morgan Keegan thinks.

On Jan. 12, 2009, Fool co-founder David Gardner, Jeff Fischer, and their Motley Fool Pro team will accept new subscribers to their real-money portfolio service. Motley Fool Pro is investing $1 million of the Fool’s own money in long and short positions in a range of securities, including common stocks, put and call options, and exchange-traded funds (ETFs). They also incorporate proprietary CAPS "community intelligence" data into their research. To learn more about Motley Fool Pro and to receive a private invitation to join, simply enter your email address in the box below.