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 ...
Shares of iRobot (Nasdaq: IRBT) are on a tear. Already up 57% over the past 52 weeks, and beating the S&P 500's performance by a 40-point margin, the stock got another big boost Friday when ace stockpicker Benchmark Capital weighed in with an upgrade to "buy."

What is it that's got Benchmark whirring, beeping, and chirruping with joy for the little Roomba-maker? Four things:

• First and most immediately, Benchmark predicts "strong" results when iRobot reports Q4 earnings early next month, and believes the company will offer "solid" guidance for fiscal 2011 as well. Benchmark predicts one whole dollar per share.
• Presumably, much of the good news will come from the company's booming business selling robotic vacuums and floor-swabbers internationally, but Benchmark also says we're getting "better visibility for military robots ..."
• Which when translated from analyst-speak into English, means Benchmark sees more certainty that the U.S. military is "committed" to buying both iRobot's "Packbot" bomb-disposal robots, and also the Small Unmanned Ground Vehicles (SUGV) that iRobot's building in cooperation with Boeing (NYSE: BA) and SAIC (NYSE: SAI). (On the flip side, I should point out that I recently received confirmation from Deere (NYSE: DE) that it has taken the R-Gator project entirely in-house, and is no longer partnering with iRobot on that one. Oh, well. Win some, lose some.)
• Regardless of the R-Gator disappointment, Benchmark believes iRobot is on track to post revenue growth in the "mid-to-high teens" over the next three years -- making the stock worth $30 per share.

So... let me get this straight. First, Benchmark says iRobot is projecting $1 per share this year, and a $30 share price -- that makes for a rather pricey 30 times P/E. Worse, Benchmark doubts iRobot will be growing even as fast as 20% per year. This is what you call a buy thesis?

Let's go to the tape
I have to tell you, Fools, when I look at the numbers Benchmark lays out in defense of its advice to buy iRobot, it makes me rather nervous. And when I look at the analyst's record in the defense and aerospace industry ...

... I have to say, that doesn't fill me with confidence, either. Granted, Benchmark only began covering the defense sector early last year, but it's not exactly off to a lightning-fast start. And it's certainly not living up to Benchmark's overall reputation for excellence -- ranked in the 95% percentile of investors tracked by CAPS, Benchmark has proved itself an ace picker of software stocks, media plays, REITs -- just not defense stocks.

Reason for hope ...
So ... is there any chance at all that Benchmark is poised to reverse its anemic performance in Defense? Actually, there is. Based on trailing-12-month performance, iRobot is currently churning out free cash at the rate of $42 million per year, or nearly twice the pace of its reported GAAP profits. With a price-to-free cash flow ratio of less than 17, it's at least possible that iRobot is a "buy" at Benchmark's projected "mid-to-high teens" growth -- especially if the company manages to expand its profit margin a bit as well, as Benchmark thinks likely.

... and reason for worry
On the other hand, though, there is the niggling little issue of inventory growth that concerns me. Last quarter, as you may recall, I called out the company for losing its beartrap grip on inventories, which iRobot had permitted to expand at nearly twice the recent pace of sales growth. If that continues, it could imperil the superb cash production we've come to expect from this company, and reduce the value of the stock considerably.

Long story short, when you add up Benchmark's less-than-stellar record in the defense sphere, its questionable logic in defense of the stock price, and the risk of cash generation stalling out -- I have to say, I'm not at all as enthusiastic about this upgrade as the rest of the market seems to be. I see danger here, Will Robinson, and suggest you get ready to pull the plug if iRobot emits any more worrisome beeps in February.