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 best ...
Welcome back from the long weekend, Fools. Hope you enjoyed it -- but if you're a Research In Motion (NASDAQ:RIMM) shareholder, I rather doubt you did. It has been four days since Swiss megabanker Credit Suisse downgraded the smartphone maker's shares to "underperform," and those shares, they're still a-tumblin' -- down 7% as of this writing.

Why such a steep sell-off in response to one analyst's say-so? Perhaps it's because Credit Suisse is, in the mind of Bloomberg, "the top-rated analyst covering the stock." So when investors see Credit Suisse chop its estimates for fiscal 2010 earnings, and introduce new estimates for 2011 that fall short of the Wall Street consensus, you can understand why they're worried. Top it all off with the analyst's price target that puts Research In Motion shares 27% lower than last Thursday's close, and well, a 10% reaction to the downgrade actually looks pretty mild. But is it the right reaction?

Survey says yes
Reviewing Credit Suisse's record, it's hard to be anything but impressed with this company's performance in the smartphone sector:

Granted, Credit Suisse has made a few mistakes along the way ...

... however, it's worth pointing out here that:

• Credit Suisse's Palm pick came out just last Friday. I will not hold a mere one-trading-day loss against the banker.
• Dell is only just starting out in the smartphone market. While it has earned a pretty miserable recent track record as a computer maker, it hasn't yet had time to start and ruin a smartphone business.

Which leaves Ericsson as Credit Suisse's only real, durable, smartphone-specific flub to date. Now weigh that against the firm's overall record of guessing right more often than wrong, its place in the top 10% of investors tracked by CAPS, and most important of all, its record of three straight correct calls on Research In Motion:

• Thumbs-down in December 2006, for five points of market outperformance
• Thumbs-up in November 2007, tacking six more points onto its record
• Then back to thumbs-down in June 2008 for a whopping 29-point win over the S&P 500

and I think I see why Bloomberg was so impressed with Credit Suisse's record -- and why investors sold off the stock on the downgrade.

And so should you
Here's why. I'll admit that at first glance, Research In Motion looks like the bargain that my Foolish colleague Rick Munarriz argued it was last week. The stock sells for only a 14.5 P/E, despite consensus expectations of 24% long-term growth. The resulting PEG ratio of 0.6 looks awfully tempting. But accepting that valuation as solid is like resting your derriere down on a three-legged stool ... that's missing two legs:

• First leg: The company's net profit, as calculated under GAAP, overstates the true cash profitability. While Research In Motion reported "earning" $1.8 billion over the past 12 months, in fact it generated less than $1.1 billion in actual free cash flow.
• Second leg: Credit Suisse, shown above to be one of the best smartphone analysts in the biz, tells us that smartphone sales will be slower than we think, and gross margins lower. Consequently, consensus expectations for 24% growth for the company are over the top -- and it's bound to fall short.

Foolish takeaway
With the stock already selling for 24 times free cash flow, and growth unlikely to measure up to expectations, I have to agree with the analyst today: There's just no margin of safety left in this stock, Fools. Research In Motion is overvalued, and bound to fall further.