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'll be tracking the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

And speaking of the best ...
One of the highest-rated "Wall Streeters" that's not actually located on the Street is rethinking its position on ailing Home Depot (NYSE: HD). Just this morning, Zurich-based UBS removed its sell rating on Big Orange by upgrading the stock to "hold."

According to the Swiss, Home Depot's 11-times-2009-earnings multiple represents a "trough" in the home-improvement retailer's historical valuation. UBS declined to sound the "all clear" on the stock -- probably a good move, considering Home Depot just announced a series of bad news, including tumbling sales and earnings, along with "material changes" to the terms of both its stock-buyback program, and the attempted sale of its Home Depot Supply subsidiary. Even so, UBS argues that the firm's problems are already priced into the stock.

Yet there's no end in sight to the housing industry's downturn, which Home Depot blames for its lackluster sales and earnings. Given the magnitude of the industry's troubles, the slow-motion catastrophe caused by the subprime debacle, and the likely continued weak demand for home-improvement goods and services, does it not seem more likely that Home Depot has farther to fall?

Let's go to the tape
I have to admit, every day's newspaper suggests that the Swiss' clock is off on this one, and that UBS is "calling the bottom" early. But before labeling UBS a gun-jumper, let's take a quick look back at its record. Maybe this firm is smarter than it appears?

At Motley Fool CAPS, we've been monitoring UBS's performance for more than a year now, and in this column, we've focused in on a whole series of specific up-or-down calls the banker has made (most recently, this one.) What we've learned is that the firm shows all the stereotypical reliability one expects of the Swiss. While its precise rank wobbles from time to time, UBS consistently places in the top ranks of investors on CAPS, a fact we designate as "All-Star" status. Currently, UBS sports a very respectable 88.14 CAPS rating -- albeit its record for accuracy leaves something to be desired.

Among its better recommendations, we find:

Company	UBS Says:	CAPS Says (Out of 5):	UBS's Pick Beating S&P By:
Apple (Nasdaq: AAPL)	Outperform	***	60 points
Dendreon (Nasdaq: DNDN)	Underperform	**	52 points
Potash (NYSE: POT)	Outperform	****	34 points

Meanwhile, among its losers are:

Company	UBS Says:	CAPS Says:	UBS's Pick Lagging S&P By:
KB Home (NYSE: KBH)	Outperform	*	33 points
Qualcomm (Nasdaq: QCOM)	Outperform	****	17 points
Sun Microsystems (Nasdaq: SUNW)	Outperform	***	16 points

Perhaps most important of all is UBS's performance with respect to Home Depot itself. Since recommending that investors sell the shares in November, UBS has outperformed the market by 11 percentage points. That suggests that UBS has a certain "feel" for this business.

Yet I can't bring myself to agree with UBS on this one. I feel a certain queasiness when analysts posit prices based on guesstimates of future earnings, compounded by further guesstimates of future growth rates on those earnings (as I described in last year's column "Dangerous Growth").

While I'll be the first to admit that past performance is no guarantee of future success, I'm much more comfortable basing my investment decisions on facts than on guesses. And the facts -- the firm's historical free cash flow in this case -- suggest to me that Home Depot remains a bit too pricey to own. Consider: Over the 12 months preceding Home Depot's most recent earnings report (which failed to include a cash flow statement), Home Depot had generated $4.1 billion in free cash flow. At today's price, that yields a price-to-free cash flow ratio of roughly 16. And relative to the analysts' long-term projected growth for the firm, that in turn yields a price-to-free cash flow-to-growth ratio of 1.3. Too rich for my blood -- especially if you believe, as I do, that the firm's weak accounting earnings in Q2 suggest that its free cash flow also suffered.

Caveat investor
That said, I'd be remiss if I failed to point out that here at the Fool, our deep-value prospecting newsletter service, Motley Fool Inside Value, is more optimistic. We've had Home Depot in our portfolio for more than two years now, and it doesn't appear likely to get sold anytime soon. Why not? One reason is that Inside Value advisor Philip Durell thinks the stock remains 27% undervalued at today's prices. As for the rest of the reasons ... well, you'll have to sign up for our free, 30-day trial offer to find out about those.

Fool contributor Rich Smith does not own shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 193 out of more than 60,000 rated players. The Fool has a disclosure policy.