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." So you might think we'd be the last people to give virtual ink to such "news." And we would be -- if that were all we were doing.

But in "This Just In," we don't simply tell you what the analysts said. We'll also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we'll be tracking the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

Question: What person in his right mind would advise buying a stock selling for several hundred dollars a share?

Answer: Anyone who has ever heard of Berkshire Hathaway (NYSE: BRK-B  ) or Google (Nasdaq: GOOG  ) .

Question: OK, well, what person in his right mind would advise buying a newspaper stock in the age of the Internet?

Answer: Deutsche Bank, which upgraded Washington Post (NYSE: WPO  ) from "hold" to "buy" this morning. You see, Deutsche understands that whatever you call it, the Post is not just the namesake newspaper -- and it hasn't been for a long, long time. Among other things, it's also a TV company (which contributes 24% of revenues and 61% of operating profits) and a for-profit educator (43% of revenues, 28% of operating profits).

Question: And that makes a difference?

Answer: Sure does. For one thing, your average newspaper company is losing money and selling for a price-to-book ratio that doesn't place a large premium on its assets. New York Times (NYSE: NYT  ) , for example, has a negative 15% profit margin and sells for a little more than three times book. Less prestigious McClatchy (NYSE: MNI  ) loses less (a negative 9% margin) but also fetches less for its assets (less than half their book value.)

Contrast those valuations with the more than 12 times book valuation that tiny education concern Strayer (Nasdaq: STRA  ) commands. Strayer earns a net margin of better than 20%. Meanwhile, the king of the hill in the education space, Apollo Group (Nasdaq: APOL  ) , boasts only a 15% profit margin, but its shares sell for more than 20 times book. Clearly, for-profit education is both a better sphere of business and receives accordingly better valuations from investors than does the pure-play newspaper biz.

Recognizing logical disconnects like these, and pouncing upon them, has helped win Deutsche a CAPS rating of 88.20. I suspect that the Post's price of just 2.4 times book value -- in between the newspapers named above, despite earning a profit in all of its divisions and earning almost twice as much from education as from newspapers -- inspired this morning's particular pounce.

Foolish takeaway
Mind you, while I understand Deutsche's logic, I don't necessarily agree with it. Remember, Deutsche has an above-average record as a stock picker, but it still gets only marginally more picks right than wrong.

The way I see it, though, the Post shouldn't be judged just on its book value, but on its profits. As good as its Kaplan education division is, and despite its profitable TV business, the analysts who follow this company generally don't expect profits to grow faster than 8% per year over the next five years. I simply don't think this growth rate justifies a multiple to trailing earnings of 26 times. Long story short, the Post is overpriced.


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