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.

And speaking of the worst...
Shares of "the Chinese Google (NASDAQ:GOOG)" -- Baidu.com (NASDAQ:BIDU) -- sank like a stone this week, weighed down by concerns over its advertising practices (to put it mildly). By Wednesday, with the shares down 28% from last week's close, Citigroup noticed something was amiss and downgraded the shares all the way from "buy" to "sell."

At which point Credit Suisse -- which has been telling folks to sell Baidu since late last year -- decided the worst was over, and upgraded the shares to "neutral."

So who's right here? Who's wrong? Is it the suddenly pessimistic Citi, or the finally (mildly) optimistic Swiss banker?

Let's go to the tape
Reviewing the bankers' respective records doesn't help us much. Both Citi and Credit Suisse have been devastated by the economic storm sweeping our gentle globe these past few months. Reviewing a few of Citi's recent upgrades, we find even highly esteemed companies are falling flat:

Nor is the carnage any less complete at Credit Suisse:

And the similarities don't end there. Across the length and breadth of their portfolios, Citi and CS are suffering similar reversals. Fully 54% of each banker's bets currently fail to match the market's returns, with the result that both Citi and CS now rank in the bottom 20% of investors tracked by CAPS.

Getting back to Baidu
So in short, neither Citi nor Credit Suisse has a lot of bragging rights these days. The reputations of both organizations seem rather threadbare, generally speaking. But what about their performance on Baidu, specifically?

Here, Citi's been the more active analyst, jumping in and out of Baidu positions three times since Feb '07. But Credit Suisse shows that sometimes, staying the course is the best course. Net-net, Citi's lagging the market by 38 percentage points on its three Baidu recommendations (two buys and a sell). Credit Suisse, in contrast, is up 16 points on its single sell call. Advantage: Credit Suisse.

Valuation
What's more, I agree more with Credit Suisse's view of the stock today than I do Citi's. Now, the math here is a little tricky, so let me walk you through the "why" of why I like Baidu at this price.

It is incredibly difficult to obtain accurate information on Baidu. Yahoo! Finance can't figure out so much as an accurate P/E on the stock. Capital IQ -- the Fool's primary data provider in such matters -- has a similarly opaque view of Baidu's profits. But by digging through the SEC files, I've been able to tally up these numbers:

• Through the first three quarters of this fiscal year, net profit as calculated under GAAP works out to $110.7 million.
• Free cash flow is approximately $113.7 million.
• The run-rate for this year, therefore, comes in at about $148 million net profit, and $152 million free cash flow.

Either way you look at it, therefore, the stock appears to be selling for about 25 times its annual profits. If Baidu comes anywhere near the 55% annual growth estimates that Wall Street posited for it prior to last weekend's blow-up, that's not just a steal of a deal -- it's highway robbery.

But even if Citi is right that Baidu's growth estimates are premised on revenue that will soon disappear as it cleans up its PR fiasco, I find it difficult verging on impossible to believe that the premier Chinese search engine will grow too slowly to justify an earnings multiple of 25.

Foolish takeaway
It's hard to fathom paying 25 times the earnings for any company in this market, but if there's any company that's worthy, Baidu may be it. How massive will the Internet -- and thus, Baidu -- become with a burgeoning middle class in China? I'll leave that up to you to ponder.