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." Here, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

And speaking of the best ...
What do you do when one of the best stock pickers in the business suddenly sounds the alarm on one of the biggest names in software? Personally, I listen up. And from what I hear, "Blue Horseshoe hates Microsoft (Nasdaq: MSFT)."

For the second trading day in a row, Mr. Softie's shares are slumping. Earnings surely share part of the blame. As fellow Fool Anders Bylund described last week, the software powerhouse admitted Friday that sales of its "all-important Windows" operating system took a 4% hit on lower PC demand. That's directly attributable to the success of Apple (Nasdaq: AAPL) and its iPad tablet. Anders also notes that it's an indication that "Google (Nasdaq: GOOG) is chipping away at Microsoft's business-software dominance" as Chrome gains momentum.

But the other reason for Mr. Softie's slide, I suspect, is the downgrade that Davenport slapped on the shares Friday. After all, there aren't a lot of stock pickers smarter than Davenport out there. The analyst ranks in the top 3% of investors we track on CAPS, and has historically been right on 60% of its recommendations. And the news gets even worse (for Microsoft shareholders): Within the software industry, Davenport's record is even better -- a superb 61% accuracy on picks ranging from Adobe (Nasdaq: ADBE) to Check Point Software (Nasdaq: CHKP) to Microsoft rival Oracle (Nasdaq: ORCL) itself:

So you can see why Davenport coming out and undercutting the Wall Street consensus with its neutral rating on Microsoft -- and suspending its price target to boot -- carries some weight.

And another thing ...
Adding to investor disdain were the comments from another analyst Friday, this one CAPS-unrated CT Capital. According to CT, Microsoft's 10-Q:

revealed that for only the second quarter in at least 10 years, the firm did not buy back net shares (repurchases minus new issuance). In fact, shares outstanding actually increased over the prior quarter. ... Over the past decade, MSFT has spent over a third of its current market value on its repurchase program, when it initially had a market value of $325 billion, or 46% higher than today. In the past 20 years, Microsoft repurchased a net $93.5 billion of its outstanding shares, surely to go down as a landmark waste of corporate cash.

Foolish final thought
Sure, one can argue that Microsoft was actually right to buy back all those shares, and that investors have just been stubbornly wrong in undervaluing its stock. What's harder to explain, though, is why Microsoft would decide that now is the "right" time to stop buying shares.

Microsoft earned $21.8 billion over the past 12 months. It's got a P/E ratio half that of Adobe, Check Point, or Oracle. And because of the vagaries of GAAP accounting, its P/E actually understates the company's real value. Free cash flow for the period ran to $24.2 billion, giving Microsoft a price-to-free cash flow ratio of just 9.0. (Back out the cash the company already has, and the valuation drops even further, to an enterprise value-to-free cash flow ratio of only 7.6.) Meanwhile, even pessimistic analysts agree that Microsoft will probably grow 10%-plus over the next five years -- and the stock's paying a generous 2.5% dividend to boot.

I ask you: With a valuation this cheap, is now really the right time to stop buying shares? I don't think so, but apparently Microsoft does. And Davenport, with its downgrade to neutral, seems to agree. What do you think?

Tell us on Motley Fool CAPS.