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 worst ...
If you're an RF Micro Devices (Nasdaq: RFMD) shareholder, please accept my condolences. In case you hadn't noticed, your shares sold off sharply yesterday, and for one of the silliest reasons imaginable: Some analyst by the name of Charter Equity downgraded your stock for the simple reason that ...

... well, actually, that's just the thing. I don't know why Charter downgraded the stock. Sure, The Wall Street Journal says the downgrade happened, and I believe 'em. But no major media outlet -- not the Journal, not nobody -- seems to know the reason for Charter's downgrade (although I have my suspicions, as you'll see below). Which I have to say, leaves investors in a bit of a quandary today.

I mean, it's not as if RF Micro goofed on its quarterly report Tuesday. Quite the opposite. As my esteemed fellow Fool Anders Bylund discussed yesterday, RF did a fine job of extricating itself from overdependence on key customer Nokia (NYSE: NOK), splitting up its revenue streams among the likes of Nokia rivals such as Research In Motion (Nasdaq: RIMM) and Motorola (NYSE: MOT).

In so doing, RF both hedged its bets against continued loss of market share by its Finnish cell phone patron -- and booked for itself a tidy profit. Sales for the quarter increased 29%, operating profit 236%, and the company reported generating free cash flow of just under $190 million for the past 12-month period -- more than twice the company's reported net income for the period. Neat tricks in any market environment, much less one in which you're busy performing a major feat of hydrological engineering on your revenue streams.

I ask you: Is this the kind of performance that demands a downgrade?

Depends on whom you ask
If you ask Charter Equity, apparently it does justify the downgrade. But then again, consider the source. According to our records on CAPS, Charter has made only about 20 public stock recommendations over the four years we've been tracking it. Admittedly, that's not a lot of data to go on, but apparently it has been enough picks for Charter to rack up a record as ... a pretty hit-or-miss analyst. Consider its record to date:

Across the length and breadth of its several semiconductors and semiconductor equipment picks, this analyst has guessed wrong nearly twice as often as right. And yet it's undeniable that from time to time, Charter does hit the ball out of the park -- and in particular here, I'm thinking of May 27, 2009, the date when Charter last told investors to buy RF Micro, setting the stage for the remarkable 63% run in the stock that ended with yesterday's downgrade.

Considering how well Charter timed its entry into RF Micro, isn't it just possible that it has timed its exit equally well?

Well, let's consider. With $94.4 million in profits earned over the past 12 months, RF Micro currently sells for a price-to-earnings ratio of less than 17. That's cheaper than any stock named in the table above, National Semiconductor excepted. It's almost precisely in line with RF's predicted long-term earnings growth rate of 16.7%. If you take these numbers at face value, you have to admit that Charter may have a point in switching its stance from "buy" to "hold" based on the latest numbers.

Or not
Personally, though, I think Charter goofed. It jumped to the easy conclusion that a PEG ratio of 1.0 equals a hold rating on the stock, when digging just a little deeper would show you that RF Micro in fact has quite a bit farther to run from this point.

Here's why: In a nutshell, I think RF's reported net income understates the true cash-producing prowess of this business. Sure, based on Tuesday's numbers, the company may have "earned" only $94.4 million over the past year. But it generated free cash flow of roughly twice that amount -- $189 million, to be precise. And viewed from this perspective, what we're really looking at here is not just a "17 P/E stock," but an enterprise valued at just 6.3 times free cash flow.

Call me crazy, call me a Fool, but to me that looks like an amazingly cheap price to pay for a mid-teens grower like RF Micro. And just to show how cheap I think the stock is, I intend to head right over to Motley Fool CAPS right now and put my reputation where my keyboard is, rating RF an "outperformer" for all the world to see.

Disagree? Want to bet against me? Be my guest. Click here right now to place your bet against the stock beating the market going forward -- and may the best Fool win.