This Just In: More 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." The pinstripe-and-wingtip crowd is entitled to its opinions, but we have some pretty sharp stock-pickers down here on Main Street, too. (And we're not always impressed with how Wall Street does its job.)

Perhaps we shouldn't be giving virtual ink to "news" of analyst upgrades and downgrades. And we wouldn't -- if that were all we were doing. Fortunately, in "This Just In," we don't simply tell you what the analysts said. We 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 track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

Square Apple, round hole at Verizon
In nature, most apples you find are more or less rotund. But according to Hudson Square Research, the Apple (Nasdaq: AAPL  ) iPhone 5 is looking a bit too angular to help Verizon (NYSE: VZ  ) .

In a note that appeared yesterday on StreetInsider.com, we learned that Hudson believes "most of the negative impact from AT&T's (NYSE: T  ) loss of iPhone exclusivity" has already been priced into the stock. But investors are missing the possibility that Apple's new iPhone 5 will be have 4G capability on AT&T's system and "more likely than not" will lack 4G capability at Verizon. When you combine this with the fact that "Verizon continues to trade at significant premium to AT&T," and the fact that it's currently experiencing "a disappointing iPhone 4 launch," Hudson believes there's good reason to sell Verizon today -- and buy AT&T instead.

So yesterday, that's exactly what Hudson did. It took the two stocks, then both rated "neutral," upped AT&T to a "buy" rating, and dropped Verizon to "sell." Was that the right call?

Let's go to the tape
At first glance, you might think so. After all, both of the recommendations Hudson has made in the "diversified telecommunication services" industry so far have worked out well for investors. Frontier Communications, recommended nearly a year ago, is beating the market's performance by 5 percentage points. TW Telecom (Nasdaq: TWTC  ) is doing even better, up 9 points.

Sadly, that's about all the good news there is to report about Hudson's record in telecoms. Turn your eye to its performance in the equipment makers that service this industry, for example, and you'll find Hudson batting a perfect record … perfectly wrong, that is:

Company

Hudson Rating

CAPS Rating
(out of 5)

Hudson's Picks Lagging S&P by:

Ceragon Networks (Nasdaq: CRNT  ) Outperform ***** 3 points
Motorola Solutions (NYSE: MSI  ) Outperform *** 19 points
Nokia (NYSE: NOK  ) Outperform ** 37 points

In all, Hudson has recommended telecom equipment stocks five times over the past year -- and gotten every single recommendation wrong. In total, its advice on these five telco-equipment names has cost investors a combined 105 points' worth of market underperformance. And call me a pessimist, call me a Fool, but I believe Hudson's steering you wrong once again.

Valuation matters
I admit that Verizon appears overpriced on the surface. I mean, sure, 29 times earnings for a 6% grower? Sure looks expensive. But dig a little deeper, and what do you see?

  • Free cash flow of $13.9 billion -- nearly four times as much as Verizon reports for its "net income" under GAAP.
  • A price-to-free cash flow ratio of only 7.4 -- much cheaper than the headline P/E ratio.
  • And in case you don't think 6% growth is a little weak to justify a 7.4 P/FCF ratio, Verizon pays out a massive 5.3% dividend yield to make up the difference.

In contrast, what does AT&T offer? Well, yes, it has a 8.9 P/E. But it also has:

  • Inferior free cash flow -- $14.4 billion FCF versus $20.8 billion reported net income.
  • A price-to-free cash flow ratio of 12.7 -- about 44% higher than the headline P/E.
  • And an inferior growth rate to boot -- less than 4% annual growth expected over the next five years.

Foolish takeaway
True, AT&T boasts a beefy dividend (5.4%) just like its rival. But to my Foolish eye, that's only goes part of the way toward covering the lack of growth at AT&T. It still leaves the stock looking pretty expensive to me. In contrast, for all its faults, and whatever the future may hold for Verizon and its entree into the iPhone race, based on its price-to-free cash flow ratio, the stock looks much cheaper than its rival today. And Hudson Square looks wrong to be selling Verizon and buying AT&T.

Which stock do you think is the better bargain: Verizon or AT&T? Don't guess. Add 'em both to your Foolish Watchlist and find out for sure.

Fool contributor Rich Smith owns no shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 507 out of more than 170,000 members.

The Motley Fool owns shares of Apple. Motley Fool newsletter services have recommended buying shares of AT&T, Apple, and Ceragon Networks and have recommended creating a bull call spread position in Apple. We 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 (10)

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 June 03, 2011, at 2:13 AM, thethreestooges wrote:

    The stock has been beaten down so bad that it open up great opportunities for a bigger profit. No pain no gain! Yes, there is risk but the reward is hugh. NOK is on sale. No backing up the truck yet. Taking a few step at a time. What's the hurry? Its an investment!

  • Report this Comment On June 03, 2011, at 2:18 AM, thethreestooges wrote:

    Also, NOK is unlike one of those high flying Chinese stocks with fake revenue and bank statement.

  • Report this Comment On June 03, 2011, at 1:23 PM, jackcrow wrote:

    I don't think T or VZ are good choices at these prices. I would deeply question why there is such a radical difference between VZ bottom line earnings and the FCF. Over time the two should track together. If not someone is gaming something.

    At this point I would argue that T's price/FCF may be more accurate then VZ's. Certainly further inquiry is required.

  • Report this Comment On June 03, 2011, at 2:58 PM, TMFDitty wrote:

    @jackcrow: Fair points. But "earnings" are easier to game than cash-in-the-bank. If you believe inquiry's required, I'd focus your efforts on why AT&T is reporting so much stronger "earnings" than it can back up with cash -- not why Verizon is actually generating so much cold, hard cash.

    TMFDitty

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