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 worst ...
The trading week started off with a bang for shareholders of Motley Fool Hidden Gems recommendation Ceragon Networks (Nasdaq: CRNT  ) . Actually, make that a bang and an echo, as not one but two of Wall Street's "best and brightest" issued upgrades to buy status. And not that we're complaining, but would it be too much to ask for, to have somebody good recommend Ceragon for a change?

Sour grapes
I mean, sure, it's great to hear that Merriman Curhan Ford thinks the stock is a buy. According to the analyst, Ceragon's stock is suffering from troubles at Clearwire (Nasdaq: CLWR  ) inflicting unwarranted collateral damage on backhaul operator DragonWave (Nasdaq: DRWI), as well as from underperformance of Aviat Networks. Yet Merriman argues that whatever its peers are doing, Ceragon at least "continues to outperform, growing 34% in 1Q10 and projecting 30%-35% growth for the year" -- even absent "a rebound in Clearwire spending near-term."

So where does Merriman seeing the growth coming from? In a word: India, which "provides a small catalyst with the conclusion of the 3G and BWA auctions, as well as the streamlining of the telecom importation restrictions."

Likewise, Morgan Joseph suggests that "the 34% decline in share price since April 24 is overdone given our estimated growth prospects for the company relative to its peers." Says MJ: "a number of dynamics warrant a higher valuation for Ceragon including improving market share, growth prospects in India, and strong data demand, which is driving demand for wireless backhaul solutions." In response, investors have flooded back into Ceragon, bidding the shares up as much as 18% in yesterday's trading.

Hold the phone
And maybe they're right to do so. I mean, here in the U.S., we know of Ceragon primarily as a supplier of wireless backhaul services to AT&T (NYSE: T  ) , but internationally, Ceragon has a whole stable of customers. Some you may have heard of, such as Nokia (NYSE: NOK  ) . Others, in more exotic locales, you may not know -- such as America Movil (NYSE: AMX  ) in the Dominican Republic ... and Vodafone (NYSE: VOD  ) in India.

So I suppose it's possible there are certain international markets where Ceragon is doing gangbusters business. Yet still, I have my doubts about this week's upgrades. Here's why.

Ceragon by the digits
First and foremost, neither Merriman nor Morgan Joseph boasts particularly ringing records of success in the Communications Equipment space. Roughly 55% of the time Merriman tells you a stock is going to beat the market, it does the exact opposite. MJ's record is even worse, as our records show 56% of its recommendations going awry in that space.

Second, I fear that Ceragon's steep sell-off may have enticed Merriman and MJ to rush in  where even Fools should fear to tread. Why? MJ cites the stock's 34% decline in price as a key reason for its renewed interest, and you get the same feeling that it's greed at an apparent bargain that's motivating Merriman.

But consider: Even after dropping a third of its market cap from its March highs, Ceragon still sells for a whopping 45 times trailing earnings, and an even steeper 51 multiple to free cash flow. Sure, analysts by and large believe the company is bound for great things and will grow earnings at a 17% clip over the next five years -- but even this rapid rate of growth, it seems to me, cannot justify the company's exorbitant multiples to earnings.

Foolish takeaway
Ceragon is cheaper to today than it was a few months ago, and according to the analysts, it's cheap for no good reason, given the great prospects for future growth.

As for me, I'm not disputing the prospects. I'm disputing the whole darn underlying theory that the stock is cheap at all. Because to my Foolish eye, it just plain isn't.

Rich's skepticism notwithstanding, Ceragon remains a recommendation of Hidden Gems. Nokia is an Inside Value selection, and America Movil is a Global Gains pick.

Fool contributor Rich Smith owns no shares of, nor is he short, any company named above. You can find him on CAPS, pontificating under the handle TMFDitty, where he's ranked No. 428 out of more than 165,000 members. The Motley Fool has a disclosure policy.


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