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 one of the best investors in the business suddenly takes a shine to one of the biggest leaps in technology since the electric light bulb? Personally, I listen up. And from what I hear, Kaufman Brothers has finally figured out the best way(s) to profit from the revolution in LED lighting.

Initiating coverage on a handful of companies in the LED space, and reinitiating on one more it had dropped, Kaufman laid out for us this morning its version of how the LED industry will be evolving. Briefly, the analyst thinks you should buy shares of Aixtron (Nasdaq: AIXG  ) and Veeco Instruments (Nasdaq: VECO  ) , but avoid LED poster-boy Cree  (Nasdaq: CREE  ) . (Although if you already own shares of that last one, go ahead and hold 'em. Don't sell yet.)

So what?
Why should you care what Kaufman says about these companies? After all, it's not as if Kaufman is infallible -- quite the contrary. Although ranked in the top 10% of investors we track on CAPS, Kaufman holds this rank largely on the size of its ratings wins, rather than their frequency. Fact is, Kaufman is actually only right on its recommendations about 51% of the time, and it's notoriously bad at timing the cyclical semiconductor industry (LED lighting is basically chip-based) -- factors that have produced an admittedly anemic record in its semiconductor portfolio of late:

 Companies

 

Kaufman Says

CAPS Says (out of 5)

Kaufman's Picks Lagging S&P by

Marvell Technology (Nasdaq: MRVL  )

Outperform

****

16 points

Intel (Nasdaq: INTC  )

Outperform

****

7 points

But on those occasions when Kaufman does guess right, investors can win big by following its advice:

Companies

 

Kaufman Says

CAPS Says (out of 5)

Kaufman's Picks Beating S&P by

Skyworks Solutions (Nasdaq: SWKS  )

Outperform

****

138 points

Cypress Semiconductor (NYSE: CY  )

Outperform

****

61 points

Cree's light dims
Now that you've met the rater, let's take a closer look at Kaufman's ratings, beginning with Kaufman's most controversial pick. When most investors think "LEDs," they probably think "Cree" -- widely believed to be leader in this space. Kaufman agrees that "CREE is a leader in the manufacturing of high brightness light-emitting diodes (HB LEDs) for various applications, the most meaningful of which is commercial lighting."

That said, Kaufman worries that the premium attached to this "leader" is just a bit too rich today. Until we see "earnings acceleration above our forecasts," Kaufman refuses to "become more constructive on the name" than its current "hold" rating. Seeing as the stock currently sells for 38 times trailing earnings -- and an astonishing 74 times free cash flow, I cannot help but agree. Cree costs too much.

Hey! This candle lights at two ends!
Not so with Kaufman's preferred picks today. In contrast to Cree's position as a leading light in manufacturing LEDs (and the premium stock price that comes with), Veeco Instruments focuses on the less high-profile work of building the "metal organic chemical vapor deposition" (MOCVD) needed to manufacture LEDs. Better still, with this lower profile comes a lower stock price -- just 13 times earnings, and a mere 9.5 times free cash flow.

Considering that most analysts agree Veeco will grow its profits at 12.5% per year over the next five years, I have to say -- Kaufman is right. This stock offers a much more compelling value proposition today than does Cree.

But even Veeco's value pales in comparison to what we find at Aixtron. Like Veeco, this second stock on Kaufman's LED wish list sells MOCVD equipment. (In fact, it dominates 60% of the market for such equipment.) And while slightly more expensive than Veeco, Aixtron still looks reasonably priced at a mere 18 times trailing earnings, and perhaps downright cheap at 14 times free cash flow.

To my Foolish eye, Kaufman has picked yet another winner here. If Aixtron grows anywhere near the 58% annual compound growth rate analysts have it pegged for -- heck, even if Aixtron misses that target by a couple kilometers -- the stock is not just a bargain. It's a steal.

Rich Smith does not own shares of (nor is he short) any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 534 out of more than 165,000 members. The Motley Fool has a disclosure policy.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

Intel is a Motley Fool Inside Value recommendation. Cypress Semiconductor is a Motley Fool Rule Breakers selection. The Fool owns shares of and has written puts on Intel. Motley Fool Options has recommended buying calls on Intel. The Fool owns shares of Marvell Technology Group.


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