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...
The flight to quality continues. Last month, I argued that investment banker RBC Capital Markets made a big mistake when it recommended buying shares of PotashCorp (NYSE: POT ) . Although PotashCorp was a fine company, its high share price and low levels of cash production told me that the stock wasn't likely to reward investors. So instead, I urged investors to consider the better bargains available at rival fertilizer makers CF Industries (NYSE: CF ) and Terra Nitrogen (NYSE: TNH ) .
Within just a couple weeks, Wall Street began coming around to the same conclusion. A few days ago, Citigroup announced it was downgrading PotashCorp (and Mosaic (NYSE: MOS ) , as well), and making CF its "top pick" in the industry instead. And now, CF has picked up yet another endorsement, as the analysts at BMO Capital Markets tell us that they, too, are upgrading CF to "outperform."
Now, I've already explained why I like CF: It has one of the lowest P/E ratios in this industry, the fastest projected growth rate, and it's the only company I know of that's currently generating greater free cash flow than it reports as net income. I won't belabor these arguments -- the numbers speak for themselves:
Free Cash Flow as a % of Net Income
|Agrium (NYSE: AGU )
Source: S&P Capital IQ and Yahoo! Finance. NA = Data not available.
Instead, what I want to do today is point out just two things. First, when it comes to picking chemicals stocks, CF backer BMO has a much better record than did PotashCorp fan RBC. Whereas RBC has managed to get fewer than 45% of its fertilizer recommendations right over the past four years, BMO correctly calls outperformers in this industry 67% of the time.
That said, even an analyst like BMO, which is right twice as often as it's wrong on fertilizer stocks, still is wrong some of the time. And it's about to be proven wrong again on its second ag pick of the week. While BMO recommends buying CF, it's also telling investors to buy Agrium. That's a mistake.
The case against Agrium
Valued at less than nine times earnings, Agrium appears to be the cheapest stock on this list. But Agrium is a stock that's "cheap for a reason." Two reasons, actually. First, as you can clearly see above, Agrium is the slowest grower of the bunch. Its projected 4% long-term growth rate means that most analysts think Agrium will struggle just to keep up with the rate of inflation over the next five years.
Even worse, the quality of Agrium's profits is suspect. If CF is the only fertilizer stock that currently generates more cash profit than it reports as net income, and PotashCorp, Mosaic, and Terra Nitrogen all -- to greater or lesser degrees -- generate less cash than net income, then Agrium is the only stock that actually underperforms the pack by failing to post any free cash flow whatsoever. Instead, Agrium burns cash... even as it claims $1.3 billion in annual earnings. (And has done so for two straight years.)
When investing in the volatile commodity fertilizer sector, it's important to distinguish between cheap-looking stocks that really are bargains, and cheap-quality stocks that are cheap for good reason. The way I see it -- the way the numbers demand that I see it -- CF is a good company selling for a great price. Agrium isn't.
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