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 ...
Christmas came early for housing investors this week, and they haven't Santa to thank for it -- but Toll Brothers (NYSE: TOL ) ... and Wells Fargo (NYSE: WFC ) .
The bell Tolled for profit on Tuesday evening, when one luxury homebuilder's good news rang out with cheer for its peers across the industry. Pre-announcing fourth-quarter earnings, Toll Brothers revealed that contracts for new home purchases have risen 42% year over year, suggesting an end at long last to the string of bad earnings quarters in homebuilding. By close of trading yesterday, D.R. Horton (NYSE: DHI ) had gained 6%, Pulte Homes (NYSE: PHM ) 8%, and Beazer (NYSE: BZH ) more than 12%. Best of all was the news for Toll Brothers itself : a 16% rise in market cap.
Predictably wowed by the news, Wells Fargo proceeded to upgrade Toll shares, arguing that competition in the upper-income brackets to which Toll caters is dwindling, while the company's strong balance sheet and substantial presence in the Northeast will help Toll beat estimates and produce a profit in 2010.
But was Toll's news really as good as all that, and is Wells right to recommend buying the stock?
Let's go to the tape
The question is a bit more complicated than it ought to be today, but let me walk you through it. Once upon a time, there was a bank named Wachovia. It made some bad bets (notably involving home mortgages) ...
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Stock
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"Wachovia" Says:
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CAPS says:
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"Wachovia's" Picks Beating (Lagging) S&P By:
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NVR
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Outperform
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*
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37 points
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Ryland
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Outperform
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*
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(44 points)
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Hovnanian (NYSE: HOV )
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Underperform
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*
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(42 points)
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... and wound up getting all et up by a bigger, smarter bank by the name of Wells Fargo. Problem is, Wells Fargo itself had -- and still has -- no public track record in homebuilding.
And why is that a problem? Well, investors just bet hundreds of millions of dollars (in added market capitalization) on the likelihood that Wells Fargo knows what it's talking about when it talks homebuilding. Yet we've little basis whatsoever for assuming it does. Viewed as "Wells Fargo," the banker has no track record in the industry. Flip it over and call this bank "Wachovia," and it's got a track record all right -- a lousy one, in which two out of the three homebuilding recs it made, went wrong.
Yet now we're supposed to believe that Wells Fargo is right in saying that Toll Brothers will earn a profit next year? This, despite the fact that the consensus of 20 other analysts -- many of whom have been following Toll for far longer than Wells -- calls for a 40-cents-per-share loss next year?
But I don't think so.
What about free cash flow, you say? Even by that measure the company looks overpriced. Running to the tune of $216 million in the year to July 31, 2009, Toll's free cash flow is a lot better than its net loss might suggest. But the market currently shows an enterprise value to free cash ratio of 18 times. That's pricy even if you believe the company will do phenomenally in the future. And I'm not at all sure of that.
Foolish takeaway
Here's the cold, hard truth, Fools: If you want to buy a house, you probably need a mortgage. And if you want to get a mortgage, you certainly need a job. With 10% of the working population unemployed, millions more underemployed, and thousands more losing their jobs every day (you heard about the layoffs at Adobe Systems (Nasdaq: ADBE ) and Electronic Arts, right?) I simply don't see how "Big Housing" can rebound next year. Or maybe even the year after.
My advice: If you profited from yesterday's upgrade, take that profit and run. Because if you try to board this housing train too early, you're like to get run over.
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