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." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

And speaking of the best...
Summer is a time for roller coasters -- and the folks over at Davenport have certainly given us our share of ups and downs lately. Three months ago, this ace software analyst warned investors away from Microsoft (Nasdaq: MSFT  ) on fears that Apple (Nasdaq: AAPL  ) and Google (Nasdaq: GOOG  ) were eating Mr. Softie's lunch. Two months ago, the analyst came back and gave the all-clear.

While iPads and Androids were still selling like Wi-Fi-enabled hotcakes, equally strong sales numbers in the PC industry had Davenport thinking that maybe, just maybe, Microsoft was as cheap as it looked. With PC shipments expected to grow 4% to 5% in 2011, and Microsoft's own sales looking likely to rise 7% in 2012 -- capped by a year-end surge as Windows 8 "for tablets" begins to ship -- Davenport argued that investors just might want to pick up a few shares ahead of all the (expected) good news.

No longer.

Mr. Softie's wild ride
According to Davenport, recent earnings reports out of NetApp (Nasdaq: NTAP  ) and Dell (Nasdaq: DELL  ) , combined with the bombshell that Hewlett-Packard (NYSE: HPQ  ) dropped on investors last week, have combined to take the shine off Mr. Softie. The analyst now worries that the "decline in public sector spending" has been sharper than previously believed. Also, PC unit sales this year "may remain flat or decline" [emphasis added].

Perversely, HP itself may be to blame for part of the PC sales decline. According to unofficial reports, the company's weekend fire sale on TouchPad tablets may have resulted in some 350,000 units sold in a single day -- robbing PC producers of significant sales possibilities.

Between this TouchPad sales blowout, rumblings elsewhere in the economy, and the disruption caused by HP's announced exit from the PC-producing business, Davenport now suspects we'll see lower overall "industry PC demand" in 2012 -- and lower sales of Microsoft-ware in consequence. The situation's simply too much in doubt for the analyst to stand by its previous $35 price target on Microsoft stock. Accordingly, Davenport has pulled its "buy" rating on the stock and "suspended" its price target.

What now?
When an investor as savvy as Davenport (ranked one of Wall Street's Best analysts on CAPS) doesn't know what to do with Microsoft stock, what's a mere Fool to do? Actually, we should do the same thing we always do: Examine the numbers. Decide if the stock looks cheap relative to its long-term prospects. Buy if it does, and don't if it doesn't.

Fools, I get why Wall Street is nervous about Microsoft today. But honestly, I don't think HP's exit from PC making changes Microsoft's value all that much. Today, Microsoft stock sells for less than nine times earnings. It's even cheaper when valued on free cash flow. And if you back out its massive cash war chest, and value the company itself, ex-cash, Microsoft's core business sells for a temptingly low 6.6 times trailing free cash flow. (With a 2.7% dividend, I might add.)

To me, that seems almost too cheap to believe. But if we can believe the price investors are charging for Microsoft today, the stock is an out-and-out steal. By my estimates, all Microsoft has to do is grow its earnings at about 4% per year (barely above the rate of inflation) over the next five years to make this stock price a fair deal. Most analysts agree that Microsoft will grow at better than twice that pace. If they're right about the company's long-term prospects, it shouldn't really matter to us whether Davenport is right about the short term.

Either way, Microsoft is dirt cheap today.

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. 395 out of more than 180,000 members. The Motley Fool has a disclosure policy.

The Motley Fool owns shares of Google, Apple, and Microsoft. Motley Fool newsletter services have recommended buying shares of Microsoft, Apple, and Google. Motley Fool newsletter services have recommended creating a position in Microsoft. Motley Fool newsletter services have recommended creating a bull call spread position in Apple.

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


Read/Post Comments (2) | Recommend This Article (4)

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 August 23, 2011, at 2:16 AM, melegross wrote:

    Well, MS HAS been growing at least fairly well, and sometimes pretty well the past TEN years. But how has that affected the stock? Poorly. The stock is substantially lower now than it was back then. When you take inflation into account, it looks worse.

    And when dividends, stock buybacks, and even pouring over $30 billion back onto investors pockets can't raise the stock, perhaps it's time to realize that no one cares about this stock anymore. Possibly, it's not a good buy, because I've been reading articles for years and years, with the writers constantly expecting this stock to rise shortly, but it never does.

    Perhaps it never will.

  • Report this Comment On August 23, 2011, at 1:48 PM, chadscards1274 wrote:

    While I don't disagree that MSFT is cheap and might be cheaper then it should be I would also urge readers to ignore melegross' comment. Just as past performance does not indicate future returns the fact that MSFT has done poorly over the last 10 years has a lot more to do with the fact that 10 years ago the stock was selling at a multiple near 50 versus today that multiple is just over 9.

    This is just once again proof that you can't just pay anything for a stock and expect it to outperform. The value you pay for a stock matters. However, I guess my thought is if I have a choice between a cheap MSFT or an equally cheap (based on growth prospects) AAPL or GOOG I would take the latter.

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