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.

Credit Suisse goes two for two
Two wrong calls in one day, that is. Yesterday, you see, French megabanker Credit Suisse decided to wade back into the Internet media industry with a pair of new picks: a buy rating on Netflix (Nasdaq: NFLX  ) , and a hold on Pandora (NYSE: P  ) .

Problem is, CS is wrong. Both of these stocks deserve to be sold -- and now I'll tell you why.

Netflix
According to Credit Suisse, Netflix will rise from its current sub-$60 level to hit $100 within a year, an easy 75% profit for anyone bold enough to buy it. Are they right or wrong?

Well, let's look at the numbers. At $57 and change, Netflix shares currently cost about 32 times earnings apiece. That would be fine if the company was growing profits upwards of 30% per year, but in fact, most analysts expect Netflix to grow at only about a 15.8% clip over the next five years -- and last quarter, the company's profits actually declined ... by 91%.

Alternatively, if you give the company every benefit of the doubt -- value it on free cash flow rather than GAAP earnings, and back out its cash to value it on enterprise value rather than market cap -- it still fetches a premium EV/FCF ratio of close to 24. To me, this suggests a stock more likely to lose 50% than to gain 75%. In short, the risk-reward here remains tilted toward risk.

There's also the competition to worry about. Netflix has made a lot of noise lately about its desire to get out of the DVDs-by-mail game and switch over to streaming only. (See: Qwikster). Lately, though, it seems everyone and his Uncle Joe has been having the same idea. Comcast (Nasdaq: CMCSA  ) is going big into streaming, while Amazon.com (Nasdaq: AMZN  ) is steadily building its streamable library as well.

Sure, these rivals may ultimately fail to beat Netflix at its game. (Bigger companies have tried and failed). But the longer they stick around, the less pricing power Netflix will have -- and the harder it will be to hit even that 16.6% growth rate analysts are counting on. (Reminder: That's the growth rate Netflix missed by 107.6% last quarter.)

Pandora
In short, I'm less than convinced by Credit Suisse's argument that Netflix is a 75% profit waiting to happen -- but what about Pandora? Here, the banker feints left with a suggestion that it's going to be conservative and only rate the stock a "neutral," but then it jabs right ahead and tells investors this one's going to $12 -- a 25% gain from today's prices.

This, too, seems overly optimistic. My misgivings about Netflix's share price notwithstanding, I will give the company credit for one thing: At least it's earning some profit. Pandora isn't, and even if it proves analysts right and manages to turn a profit next year, its earnings are likely to be so little as to give the company a triple-digit P/E ratio (193, at last report).

Pandora also falls short of Netflix's mark in one other way, in that it's not generating any free cash flow whatsoever -- nor even operating cash flow. To the contrary, over the past 12 months, this unprofitable purveyor of free music over the Internet burned through $18 million in negative FCF. (No profits from giving away music? Imagine that!) And of course, Pandora faces the double challenge of trying to turn a profit while competing with other, profitable firms that are actually able to charge for their music: Sirius XM (Nasdaq: SIRI  ) , for example. And that other company, whose name escapes me ... rhymes with "Snapple?"

Suffice it to say, I think the prospects for this one are bleak as well. If it's a 25% profit you're looking for, my advice would be to forget about Pandora, and check out our recent free Fool report, "Forget Facebook -- Here's the Tech IPO You Should Be Buying," instead.

Fool contributor Rich Smith holds no position in any company mentioned, but The Motley Fool owns shares of Amazon.com and Netflix. Motley Fool newsletter services have recommended buying shares of Netflix and Amazon.com. 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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