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 did.

But in "This Just In" we don't 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 its worst and sorriest, too.

And speaking of the worst ...
No sooner had Apple (Nasdaq: AAPL) announced that its Q1 sales surged 35%, profit margin increased 234 basis points, and net profits grew 57.5% -- and promptly saw its stock prices sell off -- when two of the least skillful "pros" on Wall Street chirped up with their thoughts. At Caris & Co., the news prompted a downgrade from "buy" to "above average." Next door at Needham & Co., the reaction was to upgrade the stock from "buy" to "strong buy."

(Both of these ratings changes will be invisible to CAPS viewers because of the way we look at these things: A buy's a buy, strong, weak, or otherwise. We're not down with quibblers here.)

Explaining their diverging views, Caris whined about Apple's "disappointing" iPod sales. I'm not sure how disappointing selling 22.1 million units could be -- and they were higher-end units than last year -- seeing as unit growth was just 5%, while revenues leapt 17%.

Needham focused more on Mac sales, pointing out that 45% growth in sales of higher-priced computers will make up for a lot of unsold low-priced music-makers. Needham sees Apple growing its computer base three times faster than Microsoft's PC growth, and argues that computer buyers pleased with their iPods but unenthused with Microsoft's Vista will continue to migrate to the Mac in increasing numbers.

Before giving my take on the situation, let's take a look at why I'm tagging these stock pickers with the "worst" label.

Let's go to the tape
Basically, it all comes down to stats. On a CAPS 100-point scale, skinny Caris weighs in at less than 20, with a record of accuracy on only a touch more than 44% of its calls. For example:

Bullish Needham doesn't do much better. With being right just over 37% of the time, this analyst's actual rating also resides somewhere south of 20. Needham's record looks like this:

So. Somewhat less-than-thrilling records for both stock pickers, I'd say. Still, both analysts were right on the money when they endorsed Apple last year. Since recommending the Mac Daddy in December, Caris has racked up 58 points of market outperformance on its pick. Needham's November thumbs-up for Apple earned in 49 points. It's hard to argue with that kind of success.

Or the lack thereof
Now it's confession time, and time for my $0.02 on Apple. A little more than one year ago I entered my first and only CAPS rating on Apple, predicting it would underperform the market. The stock promptly proceeded to double.

Way back then, when I looked at Apple's free cash flow, analysts' projections for growth, and the stock's price ... I concluded that the price was too high. Clearly, I was wrong. Not necessarily about the price, but definitely about Apple's free cash flow and growth prospects.

Over the past year, Apple has grown like a weed and become a stellar producer of free cash flow (FCF). For example, in its most recent report, the company generated $2.6 billion worth of FCF, up 53% from Q1 of last year. Added to the $3.1 billion Apple generated in the three preceding quarters, the company now has trailing FCF of $5.7 billion -- nearly 40% more than its net income under GAAP.

By my calculations, Apple stock now sells for about 20 times trailing FCF. Because analysts continue to think the company will grow in excess of 21% per year over year in the next half decade, I no longer expect Apple to underperform the market going forward. (Duh.) For that reason, I will be closing my "underperform" pick on Apple.

Got an opinion on Apple? We've got a place to voice it: Motley Fool CAPS: It's fun, it's free, and it just might make you famous.