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 track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

And speaking of the best ...
EMC (NYSE: EMC  ) shareholders enjoyed a banner day on Thursday, as their stock popped 2.3% in response in response to a pair of bullish analyst pronouncements. First up, Citigroup.

Initiating coverage on both NetApp (Nasdaq: NTAP  ) and EMC, Citi thinks investors can unlock big profits in "storage" plays. The banker views NetApp as more of a growth story, praising its focus on "the fastest growing segments of the networked storage market." And in fact, judging from estimates of future growth, NetApp is quite the sprinter. Most analysts expect this company to grow profits at the rate of 14.6% per year over the next five years -- faster than Cisco (Nasdaq: CSCO  ) , and more than twice the speed of Sun Micro (Nasdaq: JAVA  ) .

If growth's the story at NetApp, Citi views EMC as more of a turnaround situation. Calling it "the clear leader in networked storage in terms of revenue, product breadth, sales coverage and installed base," Citi argues that new products plus cost-cutting efforts have the potential to improve operating margins "when demand improves." Of course, EMC is already thrashing Hewlett-Packard (NYSE: HPQ  ) in the margins game sans demand. But if Citi's right, we could also soon see EMC close the gap with tech icon IBM (NYSE: IBM  ) , whose 18.6% operating margin currently trumps everyone else mentioned above -- save Cisco.

But you said there were two analysts. Who's the second?
Ah, yes. EMC shareholders can send their second thank-you note to the friendly folks at Broadpoint.Amtech, who gave EMC a vicarious upgrade yesterday when they initiated coverage on its subsidiary, VMware (NYSE: VMW  ) .

Like its parent company, "VMware has a significant lead on the competition" in Broadpoint's view. And unlike the more diversified EMC, VMware is a "pure-play powerhouse provider of virtualization software/services." Thus, through its expertise in virtualization -- which is a key ingredient in enabling cloud computing -- it offers investors a way of betting on that trend.

Best of all, Broadpoint's analysis of VMware supports Citi's prediction of a turnaround at parent company EMC. Citi says this will happen "when demand improves." But Broadpoint says this is already happening for VMware as customers are "finally starting to open the purse strings again." Which suggests that expanding operating margins -- and EMC's turnaround -- could be closer than you think.

I agree
I'm not necessarily in agreement on when the growth will happen. Here at the Fool, I'm notoriously leery of trying to predict the future -- at least within short-term time frames. But I do believe that the global economy will right itself, and that these firms will resume growing eventually. And to me, the valuations on both stocks today suggest that now's a great time to buy in anticipation of that growth resuming.

Oh, I know that neither stock looks cheap on its face. EMC sports a P/E of almost 30; VMware, a nosebleed-inducing 48. But there's method to Wall Street's madness when it tells you to buy these stocks. Citi didn't develop a record of 57% accuracy in the software sector by chance, you know. Nor is it a fluke that Broadpoint calls nearly 60% of its software picks correctly. These analysts are smart enough to know that "price-to-earnings" doesn't always tell the whole story. Sometimes, it's downright misleading.

Look past the P/Es and focus on actual cash generation, for example, and you'll see that EMC is selling for just 11 times its trailing free cash flow. VMware costs a little more at between 16-17 times FCF. In both instances, these numbers look attractive relative to the firms' growth prospects -- 11% for EMC, and 19% for VMware.

Plus, thanks to their proven ability to generate cash in good times and bad, neither firm carries any debt worth mentioning -- to the contrary, EMC carries more than $4 billion in net cash on its balance sheet, and VMware a tidy $1.8 billion.

Foolish takeaway
Rock-solid balance sheets, cash-producing prowess, and respectable growth rates in the toughest economic times: All of this tells me that Wall Street's right about EMC and VMware this week. Fools may want to consider picking up a few shares today -- these prices won't last.

Fool contributor Rich Smith does not own shares of any company named above (or had you already guessed?). You can find him on CAPS, publicly pontificating about stuff he does understand under the handle TMFDitty, where he's currently ranked No. 513 out of more than 140,000 members. VMware is a Motley Fool Rule Breakers recommendation. The Motley Fool has a disclosure policy.


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  • Report this Comment On August 28, 2009, at 7:36 PM, Bayviewwindow wrote:

    Something coming down soon (San Francisco next week?) with VMW - some kind of venture with EMC and/or Cisco? Share price up 15% this week.

    Be interested in Q3 Sales - company seems to have weathered the downturn and Microsoft (yawn).

    Brokers predicting $40 - will it happen?

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