This Just In: Upgrade or Downgrade

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 best ...
Wall Street megabanker Citigroup put on a new hat this morning -- and it reads "John Deere." Opining on recent trends in the ag space, Citi noted that investors today are preoccupied with worries that: "the upcoming China potash contract and the risk potash prices could fall below last year's $575/t level." Without directly contradicting that fear, though, Citi argued it's more important to focus on: "stronger grain fundamentals. There are three key reasons grain prices are moving higher, thus creating an environment for multiple expansion for fertilizer stocks: Grain Supplies Remain Historically Tight; The US Planting Season Is Seriously Behind Schedule; and Broader Market Stabilization & Easing of Deflation Concerns."

The banker/farmer doesn't think this will help everyone equally, of course. Adding valuation to the mix, Citi thinks seed-mogul Monsanto (NYSE: MON  ) , for example, already has a lot of the "good" news priced in, and will rise no further. Not so with fertilizer makers, though. In fact, in Citi's view, it all adds up to: 

  • Agrium (NYSE: AGU  ) and Archer-Daniels-Midland (NYSE: ADM  ) getting upgrades to "hold."
  • Mosaic (NYSE: MOS  ) and Potash (NYSE: POT  ) to "buy."
  • Monsanto falls to "hold."

(Incidentally, Tech Data (Nasdaq: TECD  ) and Salesforce.com (NYSE: CRM  ) also received Citi downgrades to hold, but for reasons having little to do with the price of peas in Peoria.) 

But -- do I even need to ask -- how likely is it that a Wall Street banker knows enough about farming to be calling these stocks right?

Let's go to the tape
A quick glance at CAPS suffices to tell you that overall, the odds of Citi being right on any given stock work out to about 50-50. Nearly three years of tracking the banker's performance on CAPS tells us that Citi's constantly neck-and-neck in a race to outperform a coin-flip. But that's not the whole story, Fools.

The great thing about CAPS is that it captures for us -- and reveals to you -- a wealth of information going beyond the headlines. In particular, it shows us how very active Citi has been in this sector historically ... and how successful:

Stock

Number of Recommendations in Past Two Years

CAPS says:

Citi's Picks Beating (Lagging) S&P By:

Monsanto

One

****

107 points

Potash

Two

****

79 points

Agrium

Four

*****

71 points

Archer-Daniels-Midland

One

****

9 points

Mosaic

Two

****

(72 points)

So while Citi's overall record of 50% accuracy may underwhelm, and its performance on Mosaic leaves something to be desired, the fact remains that this banker's batting .800 in the ag sector. But can it maintain this winning streak?

Personally, I have my doubts.

While it's true that most analysts on Wall Street expect to see fertilizer profits rebound strongly next year, the longer-term picture looks pretty bleak. They posit healthy 11% annual growth over the next five years for Mosaic, but just a 3.5% pace for both Potash and Agrium -- neither of which compares well to the firms' P/E ratios.

Worse still, when you look past the income statement to what these firms are generating in terms of free cash flow, not a one of 'em generates free cash flow anywhere near the numbers they report as net earnings under GAAP. Agrium in particular generated just $256 million in free cash flow last year, or less than a quarter of its GAAP income; Potash and Mosaic are tied with free cash flow backing up 40% of their GAAP earnings.

Foolish takeaway
To me, this makes the fertilizer makers look like a sucker's bet at today's prices. Yet that doesn't change the fact that Citibank has been betting and winning on these stocks for several years. Who's right this time? You pays your money and you takes your chances.

But the safest bet of all is probably to rate the stocks on CAPS (it's free), and save your real money for investing in stocks a little less commodity-driven, a bit less volatile, and a whole heckuvalot more obviously cheap.

Salesforce.com is a Rule Breakers recommendation.

Fool contributor Rich Smith doesn't own shares of any company mentioned. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 664 out of more than 130,000 members. The Fool's disclosure policy grew overnight.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 22, 2009, at 4:33 PM, mammon12 wrote:

    If you want to bash the analysts, you can't use their own estimates as ammunition against them. Either you trust them or you don't. If you look at POT's own estimates for future growth, they are much much higher than 3.5% annually. Do you personally think fertilizer growth will be in this range? Look at the last 5 years. Look at the last 10 years. Has something changed, and if so, what?

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