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 ...
OK, everybody, it's safe to get back in the financial pool. Or so says Jefferies & Co. -- and while I admit to having reservations, this is one equity lifeguard who deserves a listen. On Tuesday, Jefferies issued twin upgrades on two-thirds of the global debt-rating triumvirate: McGraw-Hill (NYSE: MHP), which owns S&P, and Moody's (NYSE: MCO), which doesn't. (Joke.)

According to Jefferies, Moody's boasts a "well-established market position," an assertion that I suspect few would argue with. More debatable are Jefferies' statements that "at current levels the difficult credit conditions are fully priced into shares," and "as liquidity returns to the credit markets throughout 2009, we expect Moody's growth trajectory to also return." Jefferies is similarly bullish on McGraw-Hill for similar reasons -- it argues that this business, too, shall revive "over the next two quarters." And so it was that Jefferies slapped "buy" ratings on both stocks.

Not to put too fine a point on it, but Jefferies has "called a bottom" on the financial crisis and thinks now's the time to jump back in.

Let's go to the tape
That's comforting to hear. Of course, any Fool worthy of a jester cap will demand more than just some analyst's say-so before investing. And at a minimum, the say-so should come from an analyst with a halfway decent record of being right.

Fortunately, Jefferies easily clears that (admittedly low) bar. With a CAPS rating sitting north of 90, and a record of 52% accuracy on past picks, Jefferies is definitely one of the better professional "players" on CAPS. Consider a few active picks in its portfolio:

I suppose it's also comforting to see that Jefferies caught the wave on rising energy prices. Good to see, too, that it tossed Thornburg to the wolves in time to profit. And yet, in other respects, it appears Jefferies was taken unaware by the speed and breadth of the mortgage market meltdown, and the spillover effects into residential homebuilding and building supplies:

I have to admit -- now that I look at the individual picks, I'm not as impressed with Jefferies' record as I thought I'd be. I don't see any particular financial industry expertise here. Signs that would indicate a preternatural prescience on the mortgage meltdown are similarly absent.

Basically, Jefferies looks like an analyst whose picks are slightly more right than wrong, and that racks up a pretty good score on the times it's right -- more than enough to counterbalance the damage from picks-gone-wrong.

Foolish takeaway
Unconvinced as I am of Jefferies' superiority in stock picking, I'm going back to my old standby, valuation, on yesterday's credit rater recommendations. What I find there, however, fails to provide much comfort. At the basest price-divided-by-earnings-divided-by-growth level, I see Moody's selling for a PEG ratio of 1.9, and McGraw-Hill PEG'ed at an even more expensive 2.3.

Mind you, both of these companies generate heftier free cash flow than they are allowed to report as "earnings" under GAAP accounting standards, and thus appear significantly cheaper on a price-to-free cash flow basis than they do under P/E. Still, they're not obviously "cheap."

With Federal Reserve Chairman Ben Bernanke calling the financial markets "still far from normal," consumer lawsuits against over-optimistic debt ratings looming, and the threat of new Congressional regulation of the debt-rating business, I'm not certain at all that now is the time to call a bottom on the financials. So while I respect Jefferies' opinion, for my part, I'm reserving judgment on yesterday's ratings. I'd suggest you "wait and see" rather than "rush out and buy" Moody's and McGraw-Hill.