This Just In: More 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." While the pinstripe-and-wingtip crowd is entitled to its opinions, we've got some pretty sharp stock pickers down here on Main Street, too. (And we're not always impressed with how Wall Street does its job.)

Given that, perhaps we shouldn't be giving virtual ink to "news" of analyst upgrades and downgrades. And we wouldn't -- if that were all we were doing. Fortunately, in "This Just In," we don't simply tell you what the analysts said. We 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.

Gaga for Google
Judging from the headlines, today's news is going to be all Apple, all the time. But over at R.W. Baird, the analysts are taking advantage of the Apple echo chamber to sneak in a stealth software bargain recommendation when no one's looking. Baird's pick: Google (Nasdaq: GOOG).

That's right. Google. You might think that the biggest name in Internet search is too big to overlook, but according to Baird, that's exactly what investors are doing these days. They're undervaluing the company's flagship Internet search advertising business, and at the same time ignoring the potential of Google's other ventures. And Baird thinks investors' failure to see the value in Google today is precisely the reason the stock is so cheap today -- and likely to rise to $650 within a year, as investors wake up and smell the coffee.

Google this
Why buy Google today? Baird begins with the basics: Internet search. According to the analyst, Google currently controls about 46% of the online advertising market. As a result, however fast that market grows as a whole, Google will grab the majority of that growth and claim it for itself -- relegating rivals like Microsoft (Nasdaq: MSFT), Yahoo! (Nasdaq: YHOO), and ValueClick (Nasdaq: VCLK) to also-ran status.

Baird sees Google growing its flagship business "between 20 percent and 25 percent over the next 3-5 years." And the way Baird figures it, $650 per share would only be about 15 times next year's earnings -- a very conservative price to pay for 20% to 25% long-term growth.

Indeed, Google could grow even faster than that. (As it did last quarter, when earnings jumped 36%.) Baird argues that "[w]ith Google Search driving the lion share of revenues and profit ... the company's secondary assets and initiatives get short shrift -- in particular YouTube [the leading online video site], Display Network [the leading online display platform], Android [the dominant and fastest mobile operating system for smartphones], and Enterprise/Apps." And that's before you even consider the potential of "Google's nascent initiatives in local and social applications."

Let's go to the tape
I have to admit -- as a Google shareholder myself, I was pretty pleased to read about how bullish Baird is about the stock. I was pleased, that is ... until I took a look at Baird's record.

You see, we've been tracking Baird's performance here at Motley Fool CAPS for some years now, and I'm afraid to report that so far, the news isn't good. Oh, Baird isn't totally without hope. It's actually done quite well on a few of its software industry picks ...

Source: Motley Fool CAPS.

But on balance and across the industry, Baird actually gets more of its software picks wrong than right -- underperforming the S&P 500 on about 56% of the recommendations it has made over the past four years. (Symantec? Adobe? Autodesk, anyone?)

And much as I'm a fan of Google myself, I have to admit, I'm beginning to wonder if Google is going to slot right into Baird's long-term record of underperformance in this industry.

Google: Buy these numbers?
Why can't I turn this frown upside down? Mainly, because I just don't like the way Google's numbers are trending lately. Consider: As recently as 2009, Google was a cash-generating giant, churning out $8.5 billion in free cash flow even as it reported "income" of only $6.5 billion. Last year, however, that relationship flipped, as Google began reporting more income than it actually backed up with cash profits. And the trend has continued to the present day. Google reported GAAP earnings of $9 billion over the past 12 months -- but generated free cash flow of only $8 billion.

That's more than it produced just a few short years ago, but at $8 billion FCF, this company currently trades for more than 21 times its annual cash profits -- significantly more than the "15x multiple" that Baird assigns the company (based on next year's supposed earnings).

Foolish takeaway
Now, it's entirely possible that Google will flip the relationship between free cash flow and GAAP earnings again in quarters to come. I hope it does. But if it doesn't, I actually think the best I can say about Google today is that if free cash flow trends continue as they are today, the stock's only fairly priced. The longer the trend continues, the more Baird's $650 share price projection will look like a pipe dream.