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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:

 Company

Davenport Rating

CAPS Rating
(out of 5)

Davenport's Picks Beating
S&P by

Adobe Underperform *** 19 points
Check Point Outperform *** 58 points
Oracle Outperform **** 90 points (!)

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.

Fool contributor Rich Smith owns shares of Google. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 587 out of more than 170,000 members.

Google and Microsoft are Motley Fool Inside Value selections. Check Point Software and Google are Motley Fool Rule Breakers recommendations. Apple and Adobe Systems are Motley Fool Stock Advisor selections. Check Point Software is a Motley Fool Global Gains pick. Motley Fool Options has recommended a bull call spread position on Apple and diagonal call positions on Adobe Systems and Microsoft. The Fool owns shares of Apple, Google, Microsoft, and Oracle. Alpha Newsletter Account, LLC owns shares of Microsoft. Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (4) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 02, 2011, at 3:35 PM, louchios50 wrote:

    just bought 400 shares of msft, 300 of vlgea, 250 shares teva last week, and tap a month ago and sold it for an 8% gain. thanks MF.

  • Report this Comment On May 02, 2011, at 4:56 PM, IdahoAve wrote:

    ambiguity! despair :( I like mr soft, I am an owner and buyer. The valuation is what gets me, so cheap, so rich, so much cash flow, so entrenched in business soft ware, the kinect sold well and presents unknown oppurtunities, maybe the nokia thing will work out. I like it, i'm buying it.

  • Report this Comment On May 03, 2011, at 6:33 AM, faust445 wrote:

    something very strange is happening around the msft stock...first, nobody has any data to show that the ipad is essentially the cause of the windows small decline in sales. in fact, with windows having sold more than 350m copies ipad sales just seem like a drop in a lake. and not that the ipad has much substance in functionality, as it's merely a browser tablet with very questionable performance. also, before the ipad even was ever announced the msft stock was depressed because analysts were worried about msft not being in the phone space. and now even the nokia deal to the analysts seems like too little too late. even before nokia win phones start raining down, windows 7 is selling like nothing else on the planet. also, the windows 8 beta is around the corner and the kinect/xbox devices are outselling very easily ipads and even iphones! chances are if apple announced an xbox-kinect like game their stock would go up a heafty %. morale of the story, analysts really don't have a clue and they eventually change their views completely and when they do nobody seems to remembmer that they were waving a different flag only months before...

  • Report this Comment On May 03, 2011, at 6:42 AM, marc5477 wrote:

    If you look closely at your friend Davenport you will quickly note that his pre-'08 crash pics were horrible ;-) Performing well post the '08-'09 crash is not not worthy. Im up well over 3000% in my real accounts and i didnt do any magic at all. No penny stocks or anything. Everything was so undervalued that even 60% accuracy is actually pathetic.

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