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.

BMO says "BMH" -- "buy more Harley"
February 2012 was kind to many automakers. Chrysler booked a 40% revenue gain. Ford (NYSE: F  ) saw its sales spike 14% higher (and won an upgrade from Standpoint Research as a consequence). Honda (NYSE: HMC  ) and Toyota (NYSE: TM  ) scored twin wins of 12% apiece. Why, even mighty General Motors (NYSE: GM  ) eked out a tiny 1% gain in its sales. While recent comments out of China suggest that the world's largest auto market could be slowing have caused concerns in the sector, this week, it's none of these four-wheeled automakers that's winning an upgrade from BMO Capital.

It's Harley-Davidson (NYSE: HOG  ) .

BMH?
No slouch on the sales floor itself, Harley scored a 9% sales gain last quarter, and according to BMO, there's more where that came from. Citing an improving economy and "amenable weather," BMO believes that "early season sales have been robust for HOG." Recent restructuring efforts could be kind to Harley's bottom line, too, and when you combine estimated sales growth and expected profit-margin gains, BMO is thinking Harley shares should be worth closer to $60 by year's end than to the $39 price target it previously set for the stock -- a 21% one-year profit.

(Let's hope so. A move to $39 would actually mean a 21% loss for this $49 stock.)

Let's go to the tape
Is BMO right about that? It's hard to judge from the analyst's record. While a long-standing "player" on CAPS, and a fairly successful one (BMO ranks in the top quintile of investors tracked by CAPS), the analyst lacks much of a record in the auto industry, or in "leisure equipment and products." BMO's sole recommendation in the industry over the six years we've been monitoring its performance, however, has in fact beaten the market -- Canadian-auto parts maker Magna International, up 22 points over the S&P 500. So that's a good start.

On the other hand, betting on two-wheeled Harley to outrun its four-wheeled peers is far from a sure thing. Sure, Harley looks cheaper than either Toyota or Honda (with which it competes on motorcycles). But at 19.4 times earnings, Harley's P/E ratio torques higher than any of the major U.S. automakers.

On the third hand, though, Harley may be a bit cheaper than it looks. You see, last year, Harley-Davidson generated $696 million in free cash flow. That's about 16% higher than the $599 million in annual "profit" for Harley, calculated under GAAP. If you look at the stock in relation to the cash it generates, therefore, what you find is that Harley is priced at just 16.2 times annual FCF.

Foolish takeaway
Now let's compare that with a version of master investor John Neff's famous "total return" ratio. According to Neff, a stock is cheap when it has a P/E (or, in this case, a P/FCF) that's equal to or less than the sum of its growth rate and its dividend yield. In Harley's case, this denominator works out to 15.7 -- which is still about half a point shy of the 16.2 we'd want to see for the stock.

Based on this, I wouldn't rush right out and follow BMO's advice to buy Harley stock today. If the stock hits its projected growth rate, it's reasonably priced. If it grows as fast as BMO says it will, it might even be close to a bargain. But "close" only counts for horseshoes and hand grenades. With stocks, all it gets you is dead money.

Looking for a real bargain in the stock market? Look no further. We have the The Motley Fool's Top Stock for 2012 for you right here.

Fool contributor Rich Smith owns no shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 399 out of more than 180,000 members.

The Motley Fool owns shares of Ford. Motley Fool newsletter services have recommended buying shares of Ford and General Motors and creating a synthetic long position in Ford. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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