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...
UPS
(NYSE: UPS  ) -- one of the best economic bellwethers American investors have -- is taking a pounding this week, hit by the one-two punch of a weak earnings report and a resulting analyst downgrade.

On Tuesday, UPS reported a lackluster second fiscal quarter, in which earnings climbed a bare 2% despite a 3.5% increase in the number of packages UPS shipped. That's not the way the way things are supposed to work. The buy thesis behind UPS goes like this: Big brown trucks are constantly circling the block, burning fuel and racking up driver time slips. Those costs are pretty much fixed, so the more packages UPS delivers along the routes, and the more times it gets to collect a fee for the shipment, the greater the company's profit margins are supposed to grow.

It's not working like that, and this has investors scared. Investors in UPS, which lost 5% of its market cap on the news, but also investors in...

  • Archrival FedEx (NYSE: FDX  ) , which dropped 2%. (Speaking of which, no, I'm still not a fan).
  • In fellow shippers Arkansas Best (Nasdaq: ABFS  ) , which lost 1%, and YRC Worldwide, which lost 10% (YRC is a much less financially stable company, you see, with a debt load 34 times as big as its own market cap, so bad news has an outsized effect upon it).
  • And even in Amazon.com (Nasdaq: AMZN  ) . As StreetInsider.com recently pointed out, news of UPS' troubles took a toll on its most famous e-tailer customer as well.

It also spooked Bank of America right out of its buy position. Yesterday, B of A pulled the rating and downgraded UPS to neutral. Was that the right call?

What can Brown do for your portfolio?
I don't think so, and I'll tell you why. Amid all the doom and gloom about UPS' prospects, there's one shining example of why this company is such a good investment: its bank account.

Over the past six months, UPS has brought in $3 billion in new free cash flow. As management pointed out, this number represented "an increase of more than $600 million over the same period last year." Which according to my calculator, works out to not a "bare 2% increase" but something closer to 25%!

Now, if you run-rate this first-half cash haul out through the next six months, what you get is a company currently generating cash at the rate of $6 billion a year. And that means that this company, now valued at $71 billion and change itself, can be purchased for less than 12 times the amount of cash it's generating annually.

Foolish takeaway
If all UPS does over the next five years is grow its profits as Wall Street expects it to, at 12% annually, then UPS meets the definition for a fairly valued stock. But the situation here is actually even better than that. In addition to growing its profits, UPS also pays out about half of each year's income in the form of a 3.1% annual dividend.

To me, this all adds up to a stock that's undervalued by about 25%, and likely to rise just as soon as Wall Street sits down and takes the time to do the math. It adds up, in short, to a stock that's worth buying. That's why I publicly recommended that investors take a position in UPS three months ago. That's why I'm sticking with this advice today.

UPS is a great American brand, and a great bargain today, but it's only one of several American Companies Set to Dominate the World over the years to come. Read about three more great investments in our new, free report.

Fool contributor Rich Smith does not own shares of, nor is he short, any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 330 out of more than 180,000 members. The Motley Fool has a disclosure policy.

The Motley Fool owns shares of Amazon.com. Motley Fool newsletter services have recommended buying shares of Amazon.com and FedEx. We 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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