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 worst ...
Recession hits us all hard, but according to Citigroup, this particular recession seems likely to hit the industrial sector hardest of all. Yesterday, the Wall Street megabanker cut its earnings expectations for a whole series of industrialists -- ITT (NYSE:ITT) and Honeywell (NYSE:HON), Danaher and Emerson (NYSE:EMR), and SPX. Only one stock found itself receiving a downgrade to a "sell" rating, though. That honor Citi reserved for Motley Fool Inside Value recommendation 3M (NYSE:MMM).

According to Citi, "Dramatic strengthening of the US dollar since July ... in conjunction with evidence that business conditions have become progressively more difficult in recent weeks spurs us to cut 2009 EPS estimates across most of our group." Citi seems to think 3M especially vulnerable to these trends inasmuch as "the weaker U.S. dollar had boosted the company's international sales in past quarters."

The weak U.S. dollar, you see, made 3M's products more price competitive, and at the same time boosted profits earned in foreign currency upon their translation into our own. Conversely, as the dollar strengthens, 3M now faces twin headwinds: On the one hand, its goods look more expensive than those of foreign rivals. On the other, sales it makes abroad buy fewer profit-dollars once repatriated to the U.S.

Logical? Sure sounds that way. But it doesn't necessarily mean that the stock should be sold. It could be that 3M's troubles are already priced into the stock. For clues as to whether Citi is correctly gauging the risk here, we turn to CAPS for a glimpse at its record on similar pronouncements.

Let's go to the tape
We don't have a record for what Citi thinks of the above stocks, except SPX (where it's lagging the S&P 500 by 19 points), but we do find that Citi has a decidedly mixed record on other industrial stocks:

It's a record that plays out, by the way, throughout the length and breadth of Citi's scorecard. With 750 picks recorded over the two years we've been tracking the banker's recommendations, we can say that at this time, Citi's record is mediocre at best. Fewer than half of its recommendations are beating the market, and on average, any given Citi pick is underperforming the S&P 500 by nearly two percentage points.

But does this mean that the banker's going to be wrong on 3M as well, ab initio? I don't believe so.

Buy the numbers
While I'd hesitate to call 3M a "sell" myself, I do see reason to be leery of buying the stock. Citi's macroeconomic concerns aside, I just don't see a lot of value in 3M at today's prices.

You see, the stock's trading for about a P/E of 12 right now. Assuming that on average, the scrum of analysts tracking it are right in their expectations of 11% long-term earnings growth, that price looks approximately fair. What tips the balance toward "overpriced," in my view, is the fact that 3M generates slightly less free cash flow than it reports as "profit" under GAAP. Specifically, it generated $3.56 billion in free cash flow over the past 12 months; but it reported $3.78 billion in net earnings.

This wouldn't bother me so much if 2008 was an aberration, but in fact, 3M has generated less free cash flow than accounting profit for three years running now.

Foolish takeaway
So, to sum up, in 3M we've got an iffy quick valuation, somewhat soggy quality of earnings, and an analyst pointing to macroeconomic storm clouds gathering outside. The fact that the analyst in question isn't doing all that well right now doesn't detract from my general impression that ... 3M might not be all that great of an investment either.