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 best ...
Here on the cusp of Halloween, Google (Nasdaq: GOOG) investors feel like kids in a candy store, being treated every day to ever-more upgrades and raised earnings as they stroll down Wall Street. But what about the sick man of the Internet -- Yahoo! (Nasdaq: YHOO)? Its paradigm-shifting partnership with Microsoft (Nasdaq: MSFT) notwithstanding, Yahoo!'s collected fewer prizes than the kid wearing the bedsheet at the Halloween costume contest.

No longer. This morning, Yahoo! won one of the coveted upgrades for itself, when Benchmark Capital upgraded its shares from "hold" to "buy." Citing "firming display trends" and "low guidance/expectations," and predicting we will hear cautious optimism from management when it reports third-quarter earnings, Benchmark thinks now's the time to buy into the story of a Yahoo! emerged from the grave.

Should you sit in rapt attention as Benchmark tells its ghost story? Or run away, screaming in horror?

Let's go to the tape
I've got my suspicions ... but rather than rush to judgment, let's first take a look at Benchmark's record. Because judging from this record in the Media and Internet Software and Services sectors, Benchmark does know a thing or two about Internet advertising and the firms that profit from it.

Stock	Credit Suisse Says:	CAPS Says:	Credit Suisse's Picks Beating (Lagging) S&P By:
Gannett (NYSE: GCI)	Outperform	**	182 points
CBS (NYSE: CBS)	Outperform	**	22 points
Interactive Data (NYSE: IDC)	Outperform	*****	(6 points)
ValueClick (Nasdaq: VCLK)	Underperform	****	(8 points)

Over the course of the eight months during which Benchmark has submitted ratings through Briefing.com, we find the analyst scoring about 54% for accuracy across these two sectors -- and beating the market by more than 120 percentage points of combined outperformance among its several picks. With a record like this, I think Benchmark deserves a fair hearing.

So what's it got to say?
First and foremost, Benchmark points out that "expectations for Yahoo!'s quarter are muted" -- and that's a good thing. Assuming Yahoo! meets Q3 guidance as expected, the stock should hold up well when it reports next week. Furthermore, investors expect new CFO Tim Morse to lowball guidance for Q4, setting up "beatable projections" for it. If and when Yahoo! then beats that guidance, Benchmark expects to see the stock rise later this year.

Sounds reasonable. And yet, Benchmark also argues that Yahoo!'s price is right, selling as it does for only "7x" next year's estimated cash flow, which the analyst calls "a recession-type multiple." It's this part of the argument that I think defies belief.

The straw that broke the Benchmark
First and foremost -- "a recession-type multiple"? Seems to me that would be appropriate, seeing as we're in a recession. But I'm not even sure that Benchmark has its math right. Based on trailing results, Yahoo!'s free cash flow amounts to just under $1.3 billion. Its market cap is $23.7 billion, so unless my calculator is on the fritz, that works out not to a "7x" multiple, but something closer to an 18x multiple.

Granted, Benchmark is postulating 2010 estimated free cash flow rather than trailing results for the second half of 2008 and the first half of 2009 -- but are these guys seriously arguing that Yahoo!'s cash flow is going to more than double over the next 12 months?

Sorry, Fools, but I don't buy it. Even if Yahoo! reaps the full $500 million in operating profits it expects from its Microsoft deal, I doubt it can increase free cash flow so much that it can reach Benchmark's projections. So if that's the linchpin of Benchmark's argument in favor of buying Yahoo! ... I'm afraid it just broke.

Foolish takeaway
Now, I haven't even mentioned the fact that Yahoo! currently has an incredible triple-digit P/E valued on trailing earnings and a forward P/E of about 40. In all honesty, Benchmark needed to bring something entirely new to the table in order to justify buying this stock.

It failed. Just don't you fail to heed my warning.