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 track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

And speaking of the worst ...
Ciena (Nasdaq: CIEN) awoke yesterday to a shock -- and a 7% drop -- when Wall Street wunderkind JMP Securities rated its stock the equivalent of a "sell."

What prompted the downgrade to "market underperform"? According to JMP, Ciena's biggest telecom customers -- AT&T (NYSE: T) and BT Group, Verizon (NYSE: VZ), and Sprint (NYSE: S) -- are engaged in serious efforts to slash capital spending to preserve profitability. And given that Ciena makes the capital equipment they buy, it's likely to take a hit.

Tack on the fact that Ciena's shares have gained 70% over the last three months, and the stock's now priced for a perfect world that's most unlikely to materialize. Result: JMP predicts that Ciena will have an operating loss of $0.25 per share this fiscal year, or a nickel worse than the rest of Wall Street expects. This would be bad news for Ciena investors, but for one thing:

JMP's just not that great of a stock picker.

Let's go to the tape
Before proceeding to critique the analyst, let's give credit where it's due. When it comes to telecom equipment makers, JMP's record to date has been pretty good:

Stock	JMP Says:	CAPS Says:	JMP's Pick Beating S&P By:
Research In Motion (Nasdaq: RIMM)	Outperform	**	140 points (over two calls)
Cisco Systems (Nasdaq: CSCO)	Outperform	****	32 points (over two calls)
Riverbed Tech (Nasdaq: RVBD)	Outperform	***	20 points

With three (or four) great telecom picks to its name already (including a previous 14-point "win" on Ciena itself), why do I disagree with JMP on this particular pick? It all boils down to the numbers. JMP's numbers (as shown by more than two years' worth of tracking on CAPS) tell us that on average, this analyst is wrong about 56% of the time, with its average recommendation tending to underperform the market by just about one percentage point.

And Ciena's numbers?
Based on trailing results, Ciena is unprofitable for the past 12 months. But if you ask most analysts, they'll tell you that this year's tepid results will give way to a strong rebound for Ciena next year, stretching out into a trend of long-term growth averaging better than 11% per year as the global economy revives and telecoms resume their build-out plans. What's more, while the GAAP numbers look undeniably ugly, over on the cash flow statement Ciena is sitting pretty with $73.6 million in trailing free cash flow.

Buy the numbers
Now, maybe JMP's right that the big four telcos that Ciena services have their doubts about this recovery right now. If you buy the long-term revival thesis, though, the company looks to be bargain-priced today for the eventual revival tomorrow.

Right now, Ciena's stock is worth about $900 million in market cap (the company itself is actually a bit cheaper, with its $125 million in net cash pushing enterprise value down to the neighborhood of $775 million). What that means is that the stock now trades for about 12.2 times its free cash flow, while the company's enterprise value-to-free cash flow is an even more enticing 10.5.

Foolish takeaway
All this makes Ciena look somewhere between reasonably valued and a pretty nice bargain. Or in analyst-speak, somewhere between a "hold" and a "buy." In my opinion, though, it doesn't justify an out-and-out sell recommendation.

Sorry, JMP. While I commend you for the nice calls on Cisco and Riverbed (and RIM!), not to mention your history on Ciena itself, I just can't agree with you here. Ciena's just not that bad a stock -- but thanks for the downgrade anyway. If investors keep pushing the price down, Ciena just might evolve into a clear-cut bargain.