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This Just In: Upgrades and Downgrades

By Rich Smith - Updated Apr 5, 2017 at 7:08PM

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Bernstein tunes in to Time Warner.

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 best …
"Best" may be too strong a word to describe today's featured analyst, but I'll give it this much: Where brand-name analysts such as UBS and Citigroup are flailing, Bernstein is doing at least an adequate job of navigating a pretty tough market. So between the moment you learn that Bernstein has upgraded Time Warner (NYSE:TWX), and the minute you discover that the analyst ranks in the 78th percentile among investors tracked by CAPS, take a sec to ponder the particulars.

Let's go to the tape
Bernstein may not be the best stock-picker on the planet, but it's not the worst, either. True, the banker has made bad bets on a string of companies operating in the telecom and e-commerce spheres:

Company

Bernstein Said:

CAPS Says (Out of 5):

Bernstein's Pick Lagging S&P by:

eBay (NASDAQ:EBAY)

Outperform

***

15 points

Cablevision  (NYSE:CVC)

Outperform

*

17 points

Amazon.com (NASDAQ:AMZN)

Outperform

**

6 points

But on the other hand, Bernstein has also made some pretty prescient predictions:

Company

Bernstein Said:

CAPS Says:

Bernstein's Pick Beating S&P by:

Nortel (NYSE:NT)

Underperform

**

57 points

AT&T (NYSE:T)

Outperform

****

19 points

Nokia (NYSE:NOK)

Underperform

****

9 points

But is Time Warner one of them? According to Bernstein, the stock is destined to outperform the S&P 500 because its cable networks are "best positioned to take share from broadcast TV."

Now, I can see critics raising at least two objections to Bernstein's major thesis. But I also see valid rebuttals to both critiques.

"Time Warner is about to spin off the cable segment"
Don't assume that makes it irrelevant. Time Warner's intentions to set Time Warner Cable free in the future don't affect its value to the parent company today. For one thing, a more valuable TWC should translate into higher value received when the parent company spins it off. For another, there's no guarantee that Time Warner will spin off TWC. Plans can change.

"Cable's just one piece of Time Warner"
Yes, but Warner's cable segment makes up the largest kingdom within the Time Warner empire. If grouped with the nominally separate Networks division, the two segments contributed the majority ($26.2 billion) of the company's 2007 revenue of $46.5 billion, and nearly two-thirds of operating profits, with a 22% operating margin. Thus, what's good for Time Warner Cable is disproportionately good for all of Time Warner.

And speaking of "all of Time Warner," did I mention that the company looks awfully cheap right now? The stock currently trades for a price-to-earnings ratio of just 8.6, despite expectations for long-term growth that exceed 10% per year. What's more, the P/E probably understates Time Warner's worth. Over the past 12 months, this company has generated free cash flow of roughly $5.9 billion, or 62% better than its GAAP earnings suggest.

Thus, the stock trades for a mere 5.1 times its free cash flow. And for naysayers who say the company has too much debt, note that Time Warner's enterprise value-to-free cash flow ratio still stands at just 10.8.

Foolish takeaway
Worst case, Mr. Market is assigning no worse than a fair value to Time Warner today. Best case, the company might be significantly undervalued.

Now, that doesn't necessarily mean Bernstein is right and that the stock will outperform the market. Fact is, investors hate debt right now. That sentiment could -- and probably will -- weigh on the shares in the near future. But longer-term investors might want to view that mistrust as a boon, and consider using the extended buying opportunity to build up a larger position.

Nokia is a Motley Fool Inside Value selection. eBay and Amazon.com are Stock Advisor recommendations.

Fool contributor Rich Smith owns no shares of any companies named above. You can find him on CAPS, pontificating under the handle TMFDitty, where he's ranked No. 895 out of more than 120,000 members. The Fool has a disclosure policy.

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Stocks Mentioned

Time Warner Inc. Stock Quote
Time Warner Inc.
TWX
Amazon.com, Inc. Stock Quote
Amazon.com, Inc.
AMZN
$137.83 (-1.13%) $-1.58
Nokia Corporation Stock Quote
Nokia Corporation
NOK
$5.08 (-2.31%) $0.12
AT&T Inc. Stock Quote
AT&T Inc.
T
$18.10 (0.56%) $0.10
eBay Inc. Stock Quote
eBay Inc.
EBAY
$48.00 (0.82%) $0.39

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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