This Just In: More 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." While the pinstripe-and-wingtip crowd is entitled to its opinions, we've got some pretty sharp stock pickers down here on Main Street, too. (And we're not always impressed with how Wall Street does its job.)

Given that, perhaps we shouldn't be giving virtual ink to "news" of analyst upgrades and downgrades. And we wouldn't -- if that were all we were doing. Fortunately, in "This Just In," we don't simply tell you what the analysts said. We 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 ...
Did Amazon.com (Nasdaq: AMZN  ) make a fatal error when it decided to challenge Netflix (Nasdaq: NFLX  ) on streaming video? At least one analyst thinks so. Yesterday, Swiss megabanker UBS announced it was downgrading Amazon.

It's not that UBS "hates Amazon," mind you. To the contrary, in its ratings note, UBS insists that Amazon "will continue to dominate e-commerce, taking share from offline / online competitors." UBS's concern is that "increased content costs and new distribution deals with hardware providers (game consoles, TVs, etc) may pressure margins for longer than originally anticipated." Put more plainly, UBS thinks the cost of streaming video through Amazon Prime is going to crush the e-commerce giant's profit margins.

Even worse, the earnings guidance that Amazon gave investors last quarter did not include the costs of "free subscription streaming" -- the new service Amazon announced last month. When you factor in the added expense of providing this service, UBS says, it's going to negate any possibility of margin improvement at Amazon this year. To the contrary, "significant competition for content deals" with companies ranging from Comcast (Nasdaq: CMCSA  ) and Netflix to Google (Nasdaq: GOOG  ) , Coinstar (Nasdaq: CSTR  ) , and Hulu (oh my!) "will only continue to heat up" -- hurting Amazon's margins.

If you recall, margin concerns did a real number on Amazon's stock price back in January. A repeat of that defeat could set up Amazon shareholders for another shocking fall. But is UBS right?

Here's hoping
I honestly don't know. By announcing its new service in February, Amazon should have given Wall Street analysts enough of a heads-up in advance of of April earnings to have plenty of time to update their forecasts and avoid an earnings surprise. (Assuming the analysts are doing their job, and not simply parroting old numbers that Amazon fed them.) There's really no excuse to be surprised.

I'm also not terribly impressed by UBS's track record in Internet and Catalog Retail. The analyst's only made two picks in the industry over the past five years, and gotten one of them right (Amazon) and the other one wrong (Netflix). Meanwhile, the Fool's own TMFZahrim boasts a record of 100% accuracy on his three picks in the industry, and he argued yesterday that Amazon's move into movie streaming won't hurt the company a bit.

Dipping a toe into the Amazon
At this point, Amazon's streaming service is just a "toe in the water" experiment, you see. If Amazon can get good rates on its content when negotiating for access to the big film libraries at Disney (NYSE: DIS  ) and Time Warner -- fine. If not, it can abandon the experiment with little loss, or simply keep providing free access to the current, very limited range of titles, as a way to leverage interest in its larger library of pay-to-rent movies, and make its Amazon Prime free delivery service a bit "stickier" with consumers.

Foolish takeaway
As for me, I'm inclined to side with my fellow Fool on this one. To me, UBS's downgrade looks like an overreaction to Amazon's news. While I recognize the risks of overpaying for content, it's not a mistake I'd expect Amazon to make. On the other hand, I see the Prime/Streaming deal as yet another tool in Amazon's toybox -- much like the deal Amazon inked yesterday with AT&T (NYSE: T  ) , enabling the latter to help the former out by selling Kindle e-readers at its retail stores. To me, Prime/Streaming is just one more incremental positive, an experiment that may help Amazon to reach the 25% annual long-term profits growth-rate that Wall Street expects of it.

While that growth rate isn't fast enough to justify the stock's current multiple of 31 times free cash flow today, I welcome UBS's downgrade as something that might help make the stock more attractively priced tomorrow.

Fool contributor Rich Smith owns shares of Google. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 587 out of more than 170,000 members. The Motley Fool has a disclosure policy.

Amazon.com, Walt Disney, and Netflix are Motley Fool Stock Advisor choices. The Fool owns shares of Google, which is a Motley Fool Inside Value pick and a Motley Fool Rule Breakers recommendation.

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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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 01, 2011, at 6:44 PM, mackietheknife wrote:

    One word of advice to Bezos: One should stick to what one knows : e-retail. Just remember what happened when Boeing got into mass-transit light rail and USN hydro-foil patrol boats. Remember, right? Surely you must remember.

  • Report this Comment On March 01, 2011, at 7:18 PM, ryandebb123 wrote:

    well, as an Amazon customer for years, I can say that the addition of streaming movies has made my subscription to Prime "stickier". I always check Amazon first, for any purchase, even if I end up buying at a store (fairly rare). However, I was planning not to renew my Prime membership, as it is a wash some years, and not that beneficial others. Now, I will keep. Not sure if I would sign up for it for only streaming though - so I don't see it as a way to attract that many new customers. I am a fairly late adopter of everything though - so maybe there is customer growth potential there.

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