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.

And speaking of the best …
What do you do when an analyst -- formerly an unabashed, pom-pom-waving cheerleader for your stock -- suddenly stops, spins on a dime, and downgrades said stock? Personally, I snap to attention, and ask: "What changed?"

And that's exactly what NVIDIA (Nasdaq: NVDA) shareholders should be doing today.

As the trading week drew to a close Friday, semiconductor specialist Needham & Co. shocked the market with a surprise downgrade of NVIDIA. Initially, I admit that I thought little of the stock's drop. After all, on a day when Google got punished with a near-8% drop in share price for reporting 31% profits growth, and the mere threat of litigation sent Goldman Sachs tumbling for a 13% loss, NVIDIA's 5% decline sort of got drowned out by all the lamentation and wailing going on elsewhere.

Or so I thought -- before I read about the reason for Needham's downgrade. And before I researched the analyst's record.

Let's go to the tape
Needham, you see, is one of the best analysts we track on CAPS -- a member of that elite group we call the "CAPS All-Stars." It hasn't been right in every instance, of course (indeed, its 57-point loss to the market on MEMC Electronic demonstrates that Needham is fully capable of making disastrous calls). But within the semiconductor industry, most of Needham's picks do outperform the market -- and by pretty significant margins:

Overall, 56% of Needham's active semi-recommendations are beating the market today, and by a combined 450 percentage points. (Yes, you read that right. No misplaced decimals here.) Semiconductors are also, incidentally, the single largest area Needham covers, out of the several industries within its coverage list.

So Needham knows its chips. Great. But what exactly was it within the chip-o-sphere that inspired Needham to reverse itself mid-cheer, and drop its rating on NVIDIA all the way from "strong buy" to "hold?" Several things -- of which Advanced Micro Devices' (NYSE: AMD) surprise report of a profit last week was only the least bit of trivia. According to Needham, much more important is the fact that the new NVIDIA "Fermi" chip has proved more difficult to produce than forecast, with only 20% to 30% of chips produced so far being "fit for use."

Worse still, those chips that are usable appear riddled with problems of their own. They consume more power than do AMD's. They produce more heat. And to top it all off, Needham says AMD's offerings offer "favorable price/performance" versus NVIDIA's Fermi.

Aside from that, Mrs. Lincoln, how was the play?
So let's see here: Low yields. High prices. Surveying the bad news, Needham opines that NVIDIA just might "lose market share in the second half of the year."

Gee, do ya think?!

And it gets worse. Right now, investors in NVIDIA are having to take it on faith that the company, currently unprofitable over the trailing-12-month period, will reverse its ill fortune and come up with a profit by the end of the year. NVIDIA's then supposed to grow that profit and, if all works out as planned, proceed to keep on growing at a 14% clip over the next five years.

Foolish takeaway
If that's the way things play out, then yeah, I suppose NVIDIA could be worth the 15-times-forward-earnings multiple that investors are currently crediting it with. If, on the other hand, this Fermi mess continues to ferment -- all these growth projections could disappear like so much froth.

So no wonder Needham removed its price target on NVIDIA last week, refusing to guess at how bad this situation is going to get. And my advice would be similar: Don't you gamble on it, either. The 5% loss NVIDIA shareholders endured last week hurts, sure. But if things are as bad as Needham makes them sound, having the chance to exit this stock with only a 5% loss just might be a gift.