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:
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.
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.
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.