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

Speaking of the best ...
As the trading week winds down, Corning's (NYSE: GLW) outlook has begun to glow green. The glow got a little brighter yesterday, when Wall Street wizard Thomas Weisel Partners upped its rating on the stock to "overweight," saying it's feeling "more positive on GLW's relative position" within the LCD glass industry.

Corning itself had a little something to do with Weisel's optimism, of course. Earlier this week, the company invited investors to view its new "Gen 10" glass factory in Sakai City, Japan. Afterwards, Corning treated them to the bullish prognosis that with LCD TV sales surging in Japan, making progress in Europe, and flat in the U.S. only because last year looked just so darn good in comparison, the company is currently able to "ship everything that we can make." Demand for Corning's product is booming, and executives at the company are ebullient.

And now Wall Street's coming around to that view as well. Is it right?

Let's go to the tape
As a longtime fan of the company (if not the stock), I'd love to tell you that yes, Thomas Weisel is right about Corning. That the company's thrown off the monkey-on-its-back of high capital investment requirements. That Corning's going to be spinning off cash, and rewarding investors handsomely. Sadly, I'm not at all convinced that's the case -- largely because of the analyst making the call.

Whether you consider Corning a member of the Communications Equipment sector, manufacturing fiber optic cable for telecoms like AT&T (NYSE: T) and Verizon (NYSE: VZ), or a maker of glass-screen components for the Computers and Peripherals industry -- Weisel is perhaps the last person you should ask about how well Corning will perform in these businesses. (In fact, we have it pegged as literally one of "Wall Street's Worst" stock pickers.)

Three years of tracking this analyst's performance have taught us that Weisel only gets about half of its guesses right in the latter sector ...

... and less than half in the former:

In other words, it's possible that Weisel is right about Corning being a bargain today -- but don't bet on it.

Drag out the dead horse
Why do I doubt that Corning's a bargain? I've said it so many times already that even I am tired of reading about how this company consistently generates free cash flow far, far below the levels that it reports as net income. (Free cash flow for the trailing 12 months, for example, comes to a respectable $1.2 billion -- but even this remains far below the firm's $2 billion in net profits.)

Corning bulls like Weisel will counter that Corning must invest a lot in capital expenditures in order to remain competitive in this cutting-edge industry. As long as the profits that Corning generates continue to look good under GAAP accounting standards, they argue, the investment is worth it -- even at the cost of lagging free cash flow. I disagree.

When a company's cost of capital exceeds the returns it earns on said capital, additional capex spending actually destroys shareholder value, in my opinion. I have seen estimates putting Corning's weighted average cost of capital at 11%. In order for Corning's capital investment program to be justifiable at an 11% WACC, you'd want to see returns on capital somewhere in the mid-double digits.

Unfortunately, Corning hasn't succeeded in earning returns on invested capital north of single digits at any time this side of the Millennium. Corning's failure to generate free cash flow anywhere near its level of reported profit suggests that this stock is not as big a bargain as its 15 P/E ratio might suggest.

Foolish takeaway
Would I like to see Corning capitalize on the momentum it showed last quarter, and close the gap between reported profits and cash flow? Sure. But for now, that's up to Corning -- and I'm not buying.