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 track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

And speaking of the best ...
What do you do when one of the best analysts in the business turns suddenly -- and wildly -- bullish on a stock that it previously shrugged off? Me, I listen up, and from what I hear, Barclays Capital thinks Capital One (NYSE:COF), American Express (NYSE:AXP), and Discover Financial are once again worth owning.

Citing "a reduction in credit costs" and falling credit card delinquency rates in July, Barclays thinks we've hit an inflection point in the consumer credit market. Things will finally stop getting worse, and start getting better instead -- with the result that earnings are headed up. Even without any "material increase in revenue growth," Barclays predicts that the simple absence of credit quality deterioration will allow these companies to earn a profit next year, get back to somewhere near "normal" in 2011, exceed their average earnings per share in 2012.

Result: Upgrades across the board to "overweight," and price target hikes of 67% for Capital One, 36% for AmEx, and 14% for Discover.

But is Barclays right?

Flip a coin
Guessing whether Barclays is calling these three stocks right this time around is, in fact, a lot like flipping a coin. I mean, sure, Barclays is a stellar analyst on most subjects. It ranks in the top 10% of investors tracked by CAPS, and gets the majority of its recommendations right.

And yet, ever since we began tracking this analyst, Barclays has split the banking sector right down the middle -- getting exactly half of its picks right. Take a look at some of them:

And while it's true that Barclays's one foray into a pure-play credit card investment -- MasterCard (NYSE:MA) -- turned out brilliantly with a 47-point market outperformance, I'm more than a little worried that the banker is making a blunder this time around.

Misplaced priorities
A key point in Barclays's buy thesis for Capital One, AmEx, and Discover is that: "the stock market has shifted its focus to valuing these stocks more on future earnings power than on defensive valuation methods like price to tangible book." That sounds like a good thing, but could in fact turn out to be the chink in Barclays's otherwise well-armored argument.

Right now, at 1.5 and 1.1 respectively, Capital One and Discover don't look terribly overpriced when valued on their price-to-tangible book ratios. (AmEx, though, sells for a P/TBV of 2.9.)

Value 'em on their earnings, though, and here's how investors might look at things:

• Capital One has a projected long-term growth rate of 11% ... and sells for 62 times next year's earnings (per Wall Street's consensus estimates).
• Discover looks even worse at 8% growth and a forward P/E of 84.
• And even AmEx, the "cheapest" of the bunch, sells for 20x forward earnings versus 10% long-term growth

Maybe Barclays finds these ratios attractive. I do not.

Foolish takeaway
While ordinarily a fan of Barclays's stock picks (for example, I enthusiastically endorsed its April upgrade of Amazon.com), I'm forced to disagree with the analyst this time around. I think these credit card stocks are headed for a rude encounter with a pair of scissors.

But hey, just 'cause I say the stocks are bad bets doesn't mean you have to agree. If you've got a different opinion, we'd love to hear it. 

Post your thoughts on:

• Capital One here,
• AmEx here,
• and Discover Financial right here.