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." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

Make a million on MAKO?
This morning, the Hulbert Financial Digest's Mark Hulbert published a column contrasting the stock performances of Wal-Mart (NYSE: WMT  ) and MAKO Surgical (Nasdaq: MAKO  ) . The former, said Hulbert, is a retail powerhouse boasting a 2.6% dividend yield, a below-market P/E ratio and a price-to-book ratio below 3. The latter: a "tiny" medical device company with a "sky-high price-to-book ratio of greater than 9-to-1," no dividend, and no profits whatsoever. Yet so far this year, MAKO has beaten Walmart's stock performance soundly, a trend Hulbert attributes to too much money chasing too few good companies in the wake of "QE2."

What does Hulbert think of the trend generally, and MAKO in particular? His column's title should give you a clue: "Junk continues to lead the market." Yet at the same time he was writing these words, out came Goldman Sachs with a slightly different opinion. As quoted on StreetInsider.com this morning, Goldman opined: "We see MAKO emerging as one of the most compelling growth stories in MedTech, with the potential to transform orthopaedic surgery through the advent of robotic technologies."

Goldman's conclusion: MAKO's "in the early stages of its growth trajectory," and even if it's gone up 57% so far this year, it's got another 43% gain ahead of it.

Dueling analysts
The contrast in opinions is so stark, it's almost comical. But what's a Fool to make of the debate? As you probably already know, our Motley Fool Rule Breakers team is pretty upbeat on MAKO, and has recommended the stock to RB members. As you can probably guess, I'm a bit less enthusiastic myself. High-priced, cash-burning MAKO is about as far as you can get from the kind of value-priced, free cash flow-positive companies I normally recommend buying.

But just for kicks, let me play devil's advocate here today (some might say literally) and tell you why it's possible that Goldman Sachs is right about MAKO today, and Hulbert and I are wrong …

Let's go to the tape
Make no mistake -- Goldman's taking a big risk here, recommending MAKO near the top of its run-up. But Goldman's also got the reputation to back it up:

Company

Goldman Rating

CAPS Rating
(out of 5)

Goldman's Picks Beating (Lagging) S&P by

Edwards Lifesciences

(NYSE: EW  )

Outperform ** 24 points
Medtronic (NYSE: MDT  ) Outperform ***** 8 points

Intuitive Surgical

(Nasdaq: ISRG  )

Underperform **** (3 points)

Source: Motley Fool CAPS.

Over the almost 18 months since I began tracking its performance on CAPS, Goldman has been right nearly twice as often as wrong on its picks in the medical devices industry. Clearly, the analyst knows a thing or two about this stuff. Just as clearly, Hulbert has grounds for skepticism. MAKO is unprofitable. It is burning cash. Its growth rate does seem to have stalled out in recent quarters.

But while I see Hulbert's points (and am inclined to agree with them), there's also grounds for Goldman's optimism. Consider that over the last five years, MAKO:

  • Grew its revenues first 8 times, then 3 times, then 10 times, before dropping down to 30% revenue growth in 2010 …
  • reversed its trend of accelerating cash burn-rates (also in 2010) …
  • and held capital expenditures to a bare minimum all the while, spending only $3.1 million on cap ex over the past 12 months.

So while the company's still deeply in the red on both a GAAP and a free cash flow basis, it seems to me at least possible that MAKO turned a corner last year. Continued revenue growth could pull the company up to free cash flow-breakeven -- and then begin generating cash for shareholders in the near future.

Foolish takeaway
Again, I'm not saying this will happen. To me, MAKO is still an exceedingly iffy proposition -- just as likely to go the way of Rule Breakers disappointment Hansen Medical (Nasdaq: HNSN  ) as it is to follow in the footsteps of Intuitive Surgical. If consistent free cash flow, a low P/E, and a strong dividend are more to your liking, you might be better off investing in another recent Goldman recommendation, Johnson & Johnson (NYSE: JNJ  ) . (Or you may not.)

But if, on the other hand, you're looking for a potential rocket stock, stamped "approved" by an analyst with a good record in the industry -- Goldman's MAKO pick just might make you rich.

Fool contributor Rich Smith does not own (nor is he short) shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 430 out of more than 170,000 members. Motley Fool newsletter services have recommended MAKO Surgical, Johnson & Johnson, and Intuitive Surgical. The Motley Fool owns shares of Johnson & Johnson and Medtronic. Motley Fool newsletter services have recommended creating a diagonal call position in Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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