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 its worst and sorriest, too.

And speaking of the worst ...
Tuesday morning opened with news of two new analyst ratings for Visa (NYSE:V) and MasterCard (NYSE:MA), as investment banker William Blair initiated coverage of both stocks at "outperform." The reaction, however, was not what you might expect: Both stocks fell.

Two things might explain this strange result. First, let's address the elephant in the living room: William Blair doesn't exactly have the sharpest slide rule on Wall Street. On average, its picks underperform the market by nearly 2% apiece, and the banker gets half of its picks wrong and half right -- two factors that add up to place Blair just shy of the bottom 20% of investors rated in CAPS.

Although it's made some smart picks, including a few in the financial sector ...

… Blair has also made some really bad calls:

Blair thinks MasterCard and Visa will win places in the first table, as consumers continue shifting their transactions to plastic cards. Blair expects this trend to be particularly pronounced among consumers in developing nations and those traveling internationally.

I agree with all of that.

So what's the problem?
The problem is valuation. Endorsing the stocks, Blair proceeds to damn both with the faint praise that Visa will grow its earnings at about 23% per year over the next five years and that MasterCard will do similarly at 22%. Yet Visa currently trades for 33 times this year's estimated earnings, while MasterCard is a relative bargain at 26 times 2008 profits.

Investors can do the math: Visa is selling for a 1.4 PEG ratio and MasterCard for 1.2 -- neither of which exactly screams "Buy me!"

But Blair did its subjects a disservice in basing its endorsement on its own valuation work. Both MasterCard and Visa might be worth owning, not because of the numbers Blair and its analyst brethren posit for the companies -- but in spite of them.

You see, both MasterCard and Visa have a history of making analysts look conservative in their growth estimates. Over each company's life as a public company, neither has ever missed an earnings estimate. To the contrary, both companies have handily trounced analyst estimates every chance they got.

Foolish takeaway
Judging from its record, William Blair is most likely wrong in estimating lower-20s growth for these two juggernauts of the financial industry. And judging from their records, both Visa and MasterCard are most likely to surprise us all with just how quickly they can grow.