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 ...
It's not easy being Cassandra, but give Wedbush Morgan credit for making the effort. This morning, the analyst hopped aboard the let's-all-bash-Google (Nasdaq: GOOG  ) bus with an initiation of coverage on the stock at "underperform." (That's analyst-speak for "sell.") 

Now, it's not that Wedbush absolutely hates Google. To the contrary, the analyst had kind words to say about many of the things Google does -- the Android and Chrome operating systems, Doubleclick, YouTube, and Ad Exchange to name just a few. Wedbush's problem with Google basically boils down to just one word: search. 

In mobile advertising, Wedbush sees increasing competition from the likes of Microsoft (Nasdaq: MSFT  ) and Apple (Nasdaq: AAPL  ) . And, yes, cell phones are getting smarter and more capable of delivering targeted advertisement. There is a reason Hewlett-Packard (NYSE: HPQ  ) and Garmin (Nasdaq: GRMN  ) are trying to horn in on this market despite the difficulties, and I suspect mobile advertising is a part of it. 

More crucially, though, Wedbush worries that Google collects "the vast majority of its revenue on a pay-per-click basis to drive traffic to websites." Lately, however, the half-billion-strong Facebook nation has usurped Google's role as the No. 1 sender of traffic to certain websites (Google's YouTube among them). In short, Wedbush thinks Facebook is going to eat Google's lunch in search. Seeing as how search accounts for about 90% of Google's business, that's a great reason to sell the stock. 

I disagree, and apparently with Google's stock up nearly 2% despite Wedbush's sell rating, so do you. Now here's why we're both right. 

Reason No. 1: Facebook isn't serious
So, Facebook will kill Google, huh? Knock 'em out of the search game? Well, that's going to be quite a trick, seeing as most big employers I know don't even allow employees to access Facebook on company time. It's kind of hard to steal search traffic when no one can access your site. 

Quite simply, Facebook isn't a tool for serious searchers. It's for people who either don't have a job (aka students, it's original target audience), or who aren't on the job at present. 

Reason No. 2: Wedbush's numbers don't add up
According to Wedbush, Google will continue to grow despite its challenges. Crunching the numbers, Wedbush predicts 15% long-term growth for Google. First off, that's faster than rivals Yahoo! and Microsoft. It's also a tad less than the 16.1% growth consensus elsewhere on Wall Street. Yet based on this number, Wedbush applies a multiple of 15 times 2011 earnings to the company, and concludes the stock will underperform the S&P from here on out. 

Balderdash. 

According to Morningstar's stats, the S&P 500 currently carries a 13.5 average forward valuation across its 500 stocks -- 10% cheaper than Google's projected P/E. But the S&P 500 is expected to grow its earnings at only 9.6% over the next five years -- 35% slower than Wedbush gives Google. How Wedbush can look at these numbers and conclude that Google will therefore underperform the market is beyond me. 

And that's not even counting the firm's $9 billion in free cash flow -- 21% ahead of reported earnings -- or its $30 billion in cash on the balance sheet. Numbers that, in my book, push the stock deep into value territory. 

Reason No. 3: Wedbush's conclusion doesn't add up, either
Did I mention that despite taking a pessimistic stance on Google's stock, and implying investors should dump it today, Wedbush actually says the shares are worth 8% more than they sell for today? It's true. At the same time Wedbush tagged Google with the sell sign, it slapped a $525 price target on the stock. 

Reason No. 4: Wedbush has a lousy track record
Now for the kicker. Every once in a while, an analyst will march way out on a limb, shout out an argument that defies common wisdom, and be proven right. Knowing ahead of time that the analyst will ultimately be vindicated isn't easy, but it helps if the analyst has a record of reliability. Wedbush does not. 

Not in the realm of Internet Software and Services, at least. To the contrary, over the nearly four years we've been following this banker, we've watched Wedbush louse up its calls time and again, making wrong calls on Akamai, VeriSign, and AsiaInfo. Across the length and breadth of the industry, would you like to guess how often Wedbush Morgan correctly calls the trajectory of the Internet stocks it covers? 

About 47% of the time.

Foolish takeaway
If all of the above has failed to convince you, and if you like those odds, by all means, sell Google short today. As for me, however, I'm sticking with a winner, and staying away from Wedbush.

Google and Microsoft are Motley Fool Inside Value recommendations. Akamai Technologies and Google are Motley Fool Rule Breakers picks. Apple is a Motley Fool Stock Advisor choice. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Google.

Fool contributor Rich Smith owns shares of Google. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 540 out of more than 165,000 members. The Motley Fool has a disclosure policy.


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