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 analysts on Wall Street up and recommends one of the hottest tech stocks around -- but one that, by any objective measure, appears vastly overpriced? Personally, I listen up, and from what I hear, Blue Horseshoe loves LED lighting.

"Blue Horseshoe" in this instance being Regions Bank affiliate Morgan Keegan, and LED lighting being represented by Cree (Nasdaq: CREE  ) . As you may recall, Cree has had a rough time of things lately, getting pounded last month when it committed the cardinal sin of promising slower growth numbers than what Wall Street wanted to hear. But this month, the news is good -- and MK is sounding the all-clear.

Noting that China is establishing new standards for use of LED lighting on public streets, and arguing the oversupply of LEDs used in the LCD TV industry is abating, Morgan Keegan predicted the "supply/demand imbalance" in LEDs will dissipate by the end of this year, opening up the possibility that Cree will resume its climb in 2011. Accordingly, the analyst raised its fiscal 2012 earnings estimate to $2.66 per share.

And the best news of all? While 15% higher than MK's previous guess, a $2.66 estimate still undershoots Wall Street consensus estimates of $2.69. So it appears a consensus is forming that Cree has fallen far enough that it's now got nowhere to go but up.

Let's go to the tape
And you know what? Maybe they're right. Maybe Cree will outperform the market. After all, if you're going to take advice on the semiconductor industry from anybody, it might as well be Morgan Keegan. Ranked in the top 10% of the investors we track on CAPS, MK also happens to have one of the best reputations around when it comes to picking semiconductor stocks:

Companies

MK Says:

CAPS Rating 
(out of 5)

MK's Picks Beating 
S&P By:

OmniVision Tech (Nasdaq: OVTI  )

Outperform

****

35 points

Microsemi Corp (Nasdaq: MSCC  )

Outperform

***

36 points

Marvell Technology (Nasdaq: MRVL  )

Outperform

****

55 points

In total, 70% of this analyst's active semi-recommendations are outperforming. And would you like three guesses which stock is MK's all-time best pick in the sector? You only need one. It's Cree -- recommended in August 2008, and a near 200-point winner over the S&P 500.

Dim the lights
Ever since General Electric (NYSE: GE  ) made its prediction last month, saying LEDs will ultimately account for 75% of its lighting business, the LED bulls have been out in force. And if anyone can tell you who the biggest beneficiary of this trend will be, it's probably Morgan Keegan. The analyst's record speaks for itself.

And yet, I have to say that when I look at the company's numbers, they appear to contradict MK's latest pick doesn't look at all "A-OK" to me.

Why? Coupla reasons: First and foremost, because whatever the company says its "profits" are, free cash flow at Cree for the past 12 months adds up to just $68 million -- or barely one third as much as Cree claims for its "net income." (Call me a skeptic, but I find it hard to call any company selling for 89 times free cash flow a "bargain.")

Admittedly, recent results could be a fluke -- a function of the inventory overhang that MK tells us is going away. It's true that, if you take a long-term view, Cree's free cash flow and its reported earnings do tend to align pretty nicely. Over the past five years, the company has generated $355 million FCF, and reported $349 million in profits.

Yet even accepting that Cree's profits are "real," viewed even under this more favorable light, we're still looking at a company selling for more than 32 times earnings here. A 32x P/E stock that most analysts -- even the ones more optimistic than MK -- say will grow at just 22% per year over the next five years.

Foolish final thought
Call me crazy, call me a Fool, but those just aren't the kinds of odds I like. I still prefer lower-P/E pick-and-shovel plays Veeco (Nasdaq: VECO  ) and Aixtron (Nasdaq: AIXG  ) over Cree.

My advice: At least until its price becomes more reasonable, let Cree grab its headlines -- and you go grab yourself the cheaper shares on sale at LED equipment makers Veeco and Aixtron.

The Fool owns shares of Marvell Technology Group, but 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. 568 out of more than 165,000 members. The Motley Fool has a disclosure policy.

Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.


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  • Report this Comment On November 18, 2010, at 2:59 PM, FoolSolo wrote:

    I agree. I put my money behind VECO and AIXG just a week ago after evaluating them against their industry group. The fundamental picture for VECO and AIXG looks more compelling and less risky, with a better risk/reward ratio. I prefer AIXG slightly because they have a better handle on debt, but otherwise both seem to be good value at this time.

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