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 ...
Some Fools say that investing in the stock market is a lot like gambling. Other Fools disagree -- but I suppose it's understandable that there are investors out there who just cannot resist spinning the wheel, and hoping to hit the jackpot. Investors like Piper Jaffray.

Yesterday, just hours before semiconductor equipment maker Applied Materials (Nasdaq: AMAT  ) was due to report earnings, the analyst spun the wheel on this stock and advised its clients to buy shares before earnings are reported this evening.

And you know what? Piper may be right about that.

Spinners may be winners
Oh, I'll admit that at 22 times trailing earnings, Applied Mats doesn't look like much of a "buy" (or even an "overweight," which is the precise term Piper applied to it). Not with most folks on Wall Street convinced the company will struggle to exceed 10% long-term profits growth. However, if you look a little deeper into their financials, here's what you'll find:

  • A company flush with cash, boasting $2.6 billion more cash in the bank than it owes in debt
  • A business that over the past 12 reported months generated $1.55 billion in free cash flow -- a number two-thirds higher than the $938 million in "earnings" it was allowed to report under GAAP accounting standards
  • An enterprise that, in consequence, currently sells for just 12 times the amount of free cash it's proven itself capable of generating over the course of a calendar year.

When you consider all this, I submit to you that 10% long-term growth doesn't look like too small a number to justify the stock price.

Making up for lost time?
So why is Piper recommending Applied Materials now? Basically, it's making up for lost time. In a striking mea culpa, the analyst apologized to its customers for having downgraded Applied Mats last July -- and depriving of the 32% profits that they could have earned on the stock, had they bought back then. Piper's analyst admitted overestimating the problems with Applied Mats' solar film business, and missed the more important story in the company's semiconductor chip equipment unit.

Now, Piper believes that as the industry transitions to building 28 nanometer chips, Applied Mats customers like Advanced Micro Devices (NYSE: AMD  ) and Texas Instruments (NYSE: TXN  ) will need to buy more manufacturing equipment to expand wafer capacity, "disproportionately benefiting AMAT." (And presumably, an analogous situation faces Intel (Nasdaq: INTC  ) and Micron (NYSE: MU  ) in their moves toward 25-nm chips.)

As a result, Piper posits that estimates for this year's AMAT-earnings are too low. The analyst believes we will hear Applied Mats promise to book something close to $10.5 billion in 2011 revenue, and earn $1.35 per share -- ahead of the Street's consensus on both points. Furthermore, Piper sees the company growing like wildfire from that point onward, and earning $1.80 per share in fiscal 2012 (a 33% one-year growth rate.)

Is Piper right about that?

Let's go to the tape
Maybe, maybe not -- but I wouldn't bet against 'em. Consider just a few examples of how well this analyst has performed in the semiconductor industry to-date:

Company

Piper Rating

CAPS Rating
(out of 5)

Piper's Picks Beating 
S&P by

Atheros Communications

Outperform

****

61 points (picked twice)

Cree (Nasdaq: CREE  )

Outperform

***

133 points

Skyworks Solutions (Nasdaq: SWKS  )

Outperform

****

326 points (!)

Over the four years that we've followed Piper's performance in the semiconductor industry, this All-Star analyst has managed to beat the market on a combined 56% of its industry picks. What's more, it seems to be getting better at this stuff as time goes on. Among the semi-stocks Piper is actively recommending today, and astonishing 67% are outperforming the S&P 500.

In other words, while you might ordinarily expect a bet that any given stock will "beat" or "miss" expectations to be a 50-50 gamble ... Piper is actually closer to twice as often right about these stocks, than it is wrong.

Foolish takeaway
Personally, I'm not a big fan of making hasty bets on "earnings eve." Why gamble on an uncertain number, after all, when just a few hours patience -- waiting for the earnings release to come out -- will give you the most accurate, up-to-date picture of a company's performance, and allow you to make an informed decision to buy or sell the stock?

That said, if you absolutely, positively (and compulsively?) have to place a bet on Applied Materials' earnings release before it happens, it seems to me you're better off betting with Piper Jaffray than against it.

Fool contributor Rich Smith does not own (nor is he short) shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 576 out of more than 170,000 members. The Motley Fool has a disclosure policy.

Intel is a Motley Fool Inside Value recommendation. The Fool owns shares of and has bought calls on Intel. Motley Fool Options has recommended a diagonal call position on Intel. The Fool owns shares of Texas Instruments.

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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