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'll be tracking the long-term performance of Wall Street's best and brightest -- and worst and sorriest, too.

And speaking of the best ...
In what some might call a brilliantly well-timed pick (and what some others might cynically mutter smells a bit too well-timed), international megabank Citigroup pulled a rabbit out of the hat yesterday. Its recommendation that investors buy Warner Music Group (NYSE:WMG) came just hours after the firm had reported a quarter's worth of declining revenues, and of earnings declining even faster. But that recommendation also came just hours before the New York Post ran a story suggesting that Warner was considering taking itself private -- which sent the stock soaring.

Was Citigroup's timing a flash of brilliance or a fluke? I have my own thoughts on the subject (which we'll get to in a moment), but first, let's examine Citigroup's record on CAPS, and see what clues it might hold.

Let's go to the tape
Citigroup ranks in the top quintile on CAPS, with a CAPS rating of 90.46 and a record of making correct calls 51% of the time. A sampling of its better recommendations includes such gems as:

Yet with the 51% accuracy number you see above, you know Citigroup has chosen a few stinkers as well. Curious what they might be? Indulge your schadenfreude here:

Getting back to Warner
Now, a few paragraphs back, I promised to talk a bit about Warner in particular. Here goes. According to Citigroup, it recommended the stock because although Warner lost money last quarter, at $0.20 pro forma, the loss was smaller than Citigroup had expected. However, if that was the case, then Citigroup was nearly alone in its ultra-pessimism. Warner's loss was in fact 33% worse than the consensus estimate of all analysts polled!

Maybe Citigroup is being upfront in its explanation, maybe not. Disagreements over Warner's projected earnings abound, and the estimates vary widely. For instance, in the current fiscal year, the "consensus" figure may be a $0.02-per-share profit -- but estimates among individual analysts vary from as bad as an $0.11 loss, to as good as a $0.19-per-share profit.

In any case, I see no need to infer that Citigroup had advance knowledge of the Post's story to explain its upgrade. Fact of the matter is, I agree with Citigroup's buy rating. The way I see it, Warner's main problem is that people aren't buying as many CDs as they used to -- but they're still buying CDs, and new revenue streams, such as digital downloads, emerge with each passing year. Meanwhile, as the industry struggles to settle upon a new, workable business model, Warner's strong free cash flow can keep it afloat, attract buyout offers, or make the stock an attractive investment if no buyout ever emerges.

As I calculate it (note that Warner uses a different definition of free cash flow in its earnings releases), the firm generated $248 million in free cash flow over the last 12 months. At its current price (up 21% over the past 24 hours), the stock trades for just seven times free cash flow. Moreover, even after you add in the firm's hefty debt load, the enterprise value-to-free cash flow ratio still looks pretty reasonable at 15x.

Who else has an opinion on Warner? Loads of people -- and on CAPS, they've all got a place to state their mind, and enjoy the fame (or infamy) that comes with a right (or wrong) call. To find out who has the absolute best record on Warner Music, just click here.