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.

A "monster" upgrade for Phillips 66
On a modestly green day for the Dow, shares of oil refiner and Buffett-darling Phillips 66 (NYSE: PSX  ) rallied more than 3% yesterday. For this, you can thank the friendly analysts at Morgan Stanley, who (perhaps encouraged by a report from "OptionsMonster" citing bullish options activity in the shares) have just upgraded Phillips to "overweight."

That's the Wall Street equivalent of a "buy" recommendation. But, should you take their advice and buy Phillips 66?

Options tell the tale
According to CNBC.com, it may be time. In a report Wednesday, the news site pointed out that the 18,000 options contracts traded the previous day were "nearly four times [Phillips'] daily average." What's more, fewer than 10% of the options traded were "puts," or bets that the stock would go down. Accordingly, it appears Wall Street traders are much more interested in betting on the upside... and not just on Phillips.

Turns out, options trading has been heavily in favor of fellow refiner Hess (NYSE: HES  ) as well, suggesting that Wall Street is moving in lockstep to bid up shares of American refiners. But, which refiners are the best bets for your portfolio? Let's take a look at a few likely suspects.

  P/E Ratio Growth Rate Free Cash Flow, as a Percentage of Net Income
Phillips 66 6.0 6.0% 70%
Tesoro 8.6 7.7% 135%
Valero 11.1 5.2% 77%
Hess 14.8 8.0% Negative
ExxonMobil 9.4 8.2% 50%


Now, that last name may surprise you. Lots of people know Exxon as a big oil producer, but what you may not be aware of is the fact that this vertically integrated oil giant also the largest oil refiner in the world.

Biggest isn't necessarily best, however. Indeed, with Exxon currently generating real free cash flow at only half the rate at which it claims to be earning "net income" under GAAP, the stock looks like one of the worst investments in refining today. Hess -- a favorite of Wall Street traders earlier in the week -- is in even worse shape, with a growth rate that doesn't come close to supporting its industry-high P/E ratio, and a negative score for free cash flow. And Valero isn't much better, sporting a mid-single-digit growth rate but a double-digit P/E, and weak cash generation to boot.

Meanwhile, Phillips 66 suffers from the same flaws afflicting its peers. This recipient of the latest upgrade in refining sports an apparently attractive PEG ratio of 1.0. But, with free cash flow so weak, it's not nearly the bargain it appears to be.

Foolish final thought
Here at the Fool, we're of the opinion that there's really only one energy stock you'll ever need to own -- and none of these companies are it. (To find out who does make the cut, read our free report on the energy industry right here). If you feel you absolutely have to own a refiner, however, the list up above does contain one stock that shows promise: Tesoro.

Valued at 8.6 times earnings, and sporting a 7.7% long-term growth rate, Tesoro looks almost as cheap at Phillips 66 on the surface. Where Tesoro really shines, however, is in its ability to produce real cash profits in excess of what it says it's "earning" under GAAP. With free cash flow running 35% ahead of reported earnings, Tesoro boasts an industry-best price-to-FCF ratio of just 6.3. Factor in the 7.7% growth rate, and a modest 1.2% dividend payout, and the stock's even cheaper than it looks.

Given my druthers, I'd pick this one over Phillips 66 any day of the week.

Fool contributor Rich Smith does not own (or short) shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 288 out of more than 180,000 members. The Motley Fool has a disclosure policy.

The Motley Fool owns shares of ExxonMobil. 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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