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.

Deutsche ditches Cree
My, how time flies. Was it only earlier this month that we were reading here about how analysts at Wedbush had taken a shine to LED lighting star Cree (NASDAQ: CREE  ) , and upgrading the stock to "outperform"? At the time, I applauded the analyst's decision. I praised Cree's strong free cash flow, rock-solid balance sheet, and reasonable valuation, and concluded: "Long story short, I'd rather be long this stock than short."

And yet, here we are again just a few short weeks later, and what do we see? Deutsche Bank, kicking Cree in the teeth, and kicking it off the banker's buy list. Why?

Good news is bad news
When you listen to Deutsche's reasoning, it sounds like the stock has only itself to blame. Up 35% over the past year, and up 50% year-to-date, Cree has become a victim of its own success. As Deutsche points out, that's a gain fully 39 percentage points better than the S&P 500 has booked. With the shares now trading toward the "high end of historical valuation range/premium to peers," says Deutsche, it's time to take some profits -- and in the process, avoid "potential revenue risks ahead."

What risks? According to the analyst, Cree's products are selling well today. But the upcoming March quarter is "seasonally weak" for Cree. Plus, the banker worries that "a slowdown from Superstorm Sandy" could hurt Cree's sales in the near term.

Result: Deutsche downgrades to hold, and assigns a $33 price target to the shares.

Is that fair?
Honestly, I don't think it is fair, and I'll tell you why. First off, the situation with Cree really hasn't changed much since Wedbush -- and I -- endorsed Cree's stock just a few weeks ago. The stock's P/E ratio, while still high at 76.5 times earnings, is right about where it was earlier this month. The stock's growth rate, and free cash flow numbers, are likewise essentially unchanged.

Growth estimates for the company remain a slow and steady 13.5%. Free cash flow, a heady $212 million, is more than four times the number showing up on Cree's income statement as "net income." When you factor the company's $817 million in cash into the picture (Cree has no debt), the enterprise-value-to-free-cash-flow ratio on this stock comes up as a most attractive 13.4, and is easily justified by the growth rate.

Facts on the ground
Cree's valuation, therefore, really doesn't look that scary to me. And even if it's true that the quarter coming up, Cree's fiscal third, is seasonally weak, then it's also true that the quarter coming right after it -- fiscal Q4 -- is seasonally strong. Last year's Q4, for instance, boasted the best free cash flow number Cree's seen in a year.

What's more, facts on the ground suggest Deutsche may be exaggerating fears of LED sales weakness somewhat. Remember that Best Buy (NYSE: BBY  ) recently announced it was partnering with Cree to help it develop a line of private-label "Insignia" LED bulbs for the electronics chain. That's hardly a development suggestive of weakened demand for LEDs.

And just earlier this week, General Electric (NYSE: GE  ) announced it is buying an LED lighting fixtures company that specialized in "all-LED" lighting for enterprise customers. On the one hand, that suggests heightened interest in the technology. And on the same hand, it's worth mentioning that GE is already a partner with Cree in the manufacturing of LED bulbs. So guess who stands to benefit if GE's bet on LED lighting pays off...

Foolish takeaway
Long story short, there are many ways for an investor to participate in the global switchover to LED lighting. You can buy a company like Rubicon Technology (NASDAQ: RBCN  ) , which makes crystal diodes for the things ("LED," remember, means light emitting diode). You can buy a company like Aixtron (NASDAQ: AIXG  ) , that makes the equipment that companies like Cree use to manufacture the things.

In either of those cases, though, you're buying a company that's taken one of the greatest revolutions in energy-saving to hit the planet -- and found a way to lose money and burn cash in the midst of it.

As for me, if I were investing in LEDs, I think I'd ignore Deutsche's advice this week. I'd invest in the company that's generating great piles of cash, and has the balance sheet to prove it. I'd go ahead and pick up a few shares of Cree.

Can you really make money on an investment as mundane as light bulbs? With Cree you can, and not only with Cree. In our new free report, read about three other less-than-luxurious stocks that ordinary investors and everyday consumers can profit from. Just click here to read it now.


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  • Report this Comment On December 01, 2012, at 1:17 AM, anthonyms wrote:

    I agree with the potential, but I think the share price is compromised by the fact the cash flow seems to end up neither benefitting share holders in the form of share price growth nor in terms of dividend income. Instead the company assets seem to be expended on massive executive pay packages, inflated executive share options which allow insiders to benefit from market capitalisation growth at the complete expense of share holders or goes towards acquisitions of companies that fail or that should have been home grown Cree divisions all along.

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