This Just In: Upgrades and Downgrades

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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 worst ...
Halloween's over, but the frights keep on coming for investors in stem cell research shop Geron (Nasdaq: GERN). Most recently, former Geron booster Needham & Co. downgraded the stock yesterday. Said Needham:

• "We applaud the ... progress with the FDA on the thoracic spinal cord injury program, with the potential for a more expeditious move in cervical spinal cord injury (an area of unmet need among the 11,000 spinal cord injuries each year)."
• "The Phase 2 trial for GRN163L (imetelstat) going forward is well designed and builds on the ongoing trials, especially the breast cancer program planned."
• And for all you picky pessimists worried over Geron's cash bonfire, Needham reassured that: "At the end of 3Q09, Geron had $179MM in cash, cash equivalent and investments. With a burn rate in the range of $48MM, we believe the Company will have sufficient cash to support ongoing research and clinical development through 2011."

Hold up a sec. You say this was a downgrade?
Yeah, I know. Needham's making some pretty optimistic points in defense of its new "hold" rating on Geron. But remember that Needham has historically been pretty bullish on the stock, and on biotech in general -- not that it has always paid off ...

Stock	Needham Says:	CAPS says:	Needham's Picks Beating (Lagging) S&P By:
Vertex Pharmaceuticals (Nasdaq: VRTX)	Outperform	***	20 points
Gilead Sciences  (Nasdaq: GILD)	Outperform	*****	(24 points)
Dendreon (Nasdaq: DNDN)	Outperform	**	(28 points)
Arena Pharmaceuticals (Nasdaq: ARNA)	Outperform	***	(32 points)

In fact, far fewer than half (37%) of the 29 recommendations Needham has made in this industry over the past three years have paid off for its clients. At least according to our tracking on CAPS. It makes a Fool wonder: What's Needham doing wrong?

What Needham's doing wrong
The answer to this question, and the answer to the question earlier suggested -- why did Needham downgrade Geron if it's got such high hopes for the stock? -- can be found in the following comments from the downgrade:

• Regarding GRN163L, Needham fears: "we cannot expect to see Phase 2 data from these programs until 2011."
• Meanwhile, regarding Geron's thoracic spinal cord injury program, with GRNOPC1: "additional ... pre-clinical work [will be] required [and the] Phase 1 GRNOPC1 trial in thoracic spinal cord injuries is now projected by management to begin in 2H10, which is later than our earlier expectations, and more importantly, does not provide an opportunity for near-term newsflow." [emphasis added]

Now, I added those italics to illustrate the fatal flaw in Needham's thinking. The analyst is playing Geron as a "story stock," one entirely dependent on positive PR to support its stock price. If "newsflow" is good, the stock can soar. But when the news is lacking (or bad) -- look out below.

To my mind, that's entirely the wrong way to invest, because let's face it, folks: We have no idea what the future holds, or what news will come out of Geron. In contrast, we know for a certainty that:

• Geron's burning upwards of $40 million in cash every year.
• It's got zero chance of earning a profit, or producing cash flow, until it gets some products on the market.
• Yet so far, the best we can hope for is that Geron's cash will hold out until positive "newsflow" appears some six to 18 months hence. Not cash. Not profits. Newsflow.

Foolish takeaway
My advice, therefore, is to ignore Needham's manic-depressive musings on Geron. Instead, heed my fellow Fool Brian Orelli's advice. If you absolutely, positively must invest in stem cells, avoid cash-burning R&D shops like Geron, and focus instead on established players like Pfizer (NYSE: PFE) and GlaxoSmithKline (NYSE: GSK) -- companies with more stable sources of revenue, cash flow, and profits that allows them to move into this interesting field, without worrying about "newsflow."