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 …
Were you thrilled by Intel's (Nasdaq: INTC) earnings beat last month? Did you cheer as Advanced Micro Devices (NYSE: AMD) crushed Wall Street estimates, and shrug off the news that Texas Instruments (NYSE: TXN) only "met" its consensus numbers? Are you, as they say, "bullish on semiconductors"? 

If so, then UBS has a message for you: Settle down. Because according to UBS, the rally in semiconductors is overblown, and one company in particular is likely to get blown under -- the same company that builds the equipment that helps some of the world's biggest semiconductor companies churn out their chips: Applied Materials (Nasdaq: AMAT).

Hot chips, mild salsa
According to UBS, semiconductor equipment sales are set to grow 92% this year in comparison with 2009, followed by a further 16% sprint in 2011. So, why downgrade Applied Materials in the midst of a chip-equipment boom? 

Basically, because "nothing lasts forever" -- including the good times for semiconductors. According to UBS, no sooner do we shift into fifth gear next year than it'll be time to throttle down to neutral. UBS says: "our analysis of semiconductor industry capital intensity shows that we are about to overshoot the historical regression trend. Even on revised up semiconductor sales forecasts … we are at 10% cap ex to sales and likely trending higher to 15% capex to sales." Chip-making equipment sales could tumble as much as 12% as 2011 rolls over into 2012. 

Let's go to the tape
And they may be right. After all, UBS has been on an absolute tear in the semiconductors sector lately, scoring big wins over the S&P 500's performance on all three of the chip makers named above, and more besides:

UBS called the downturn on NVIDIA long before the company dropped its bombshell last week. It correctly called the trend in mobile computing that has lifted Skyworks' shares. Why, it even managed to grab a small gain on Cree, as the lighting industry's move toward LED light "bulbs" took traction.

And now, this self-same analyst says it's time to tap the brakes. "Foundry cap ex will moderate," UBS grumbles. "DRAM oversupply." "Monthly global semicap orders … only 5% below 2Q06 peak levels." These are just a few of the concerns UBS cites in warning that, while "we are firing on almost all cylinders now versus primarily memory in 2006," the very fact that we're approaching such a peak contains the inherent risk that there's a cyclical top looming.

I agree.

Listen, Fools, I'll be the first to acknowledge the attractiveness of Applied Materials' stock today. It doesn't seem fair that the stock's down 15% over the past year, when major customers like Intel and AMD are both up for the year. It doesn't seem right. With forward earnings projected to be strong at Applied Materials, with free cash flowing far faster than the company can report it as "net income" under GAAP accounting principles, there's certainly a case to be made that the company's best days are still ahead of us.

That said, I also have to acknowledge the points UBS is making. With a price-to-free cash flow ratio north of 14, and long-term growth (i.e., that which climbs up to the peak in 2011, then slides down the reverse slope afterward) projected to average just over 13% per year over the next five years, Applied Materials may not look terrifyingly pricey today -- but neither is it a screaming bargain.

Foolish takeaway
Considering how well UBS has acquitted itself so far in charting the tops and turves of this topsy-turvy, cyclical industry, and considering how the valuation on the stock really doesn't offer a clear-cut bargain, I think discretion really is the better part of profits here. "Hold" is the right rating for Applied Materials.