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 track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

And speaking of the best ...
Shares of U.S. Steel (NYSE:X) pushed higher today, boosted by a timely upgrade from star stock picker KeyBanc Capital Markets. According to the analyst, it's beginning to see "emerging industry momentum" in the steel sector, which should result in both "pricing and demand recovery in U.S. flat-rolled markets."

Now interestingly, this investment thesis seems to fly in the face of a story from this morning's Wall Street Journal. The Journal describes a situation of anemic global demand and high fixed costs, which is driving U.S. steelmakers such as AK Steel (NYSE:AKS) and Allegheny Technologies (NYSE:ATI) to raise prices. But the thing is, prices are rising not because demand is so strong, but because steelmakers can no longer cover their fixed costs at the price "the market will bear" -- which would appear to cut off KeyBanc's argument at the knees.

As President John Adams once observed: "Facts are stubborn things." Which leads this Fool to ask: Is there any reason to follow KeyBanc's advice when it seems contradictory to the facts on the factory floor?

Let's go to the tape
As a matter of fact, there is: KeyBanc's record. Over the course of three years of data-crunching in CAPS, we've established that, overall, 55% of the time KeyBanc says a stock is going up -- it does just that. And on average, the banker's recommendations outperform the market by nearly six points per pick, helping to lift this banker into the ranks of the top 10% of the investors we track.

However, within the metals and mining sector in particular, the analyst has been struggling of late, racking up de minimus wins ...

^Two recommendations, the latter of which was pulled in February 2009.
^^Downgraded from buy this morning.

 ... and substantial losses:

^Downgraded from buy this morning.
^^Recommendation pulled in February 2009.

Interestingly, you'll note in the above tables that two of KeyBanc's picks -- Nucor and Reliance Steel -- were cut just this morning, at the same time that the analyst was upgrading U.S. Steel. The analyst explained the disconnect by saying both Nucor and Reliance have enjoyed "generally superior share price performance achieved over the 4Q08/2Q09 time frame." KeyBanc thinks the prospects for U.S. Steel now exceed the chances of these two picks continuing their runs.

Buy the numbers
For my part, though, I'm not convinced. On the one hand, I agree that U.S. Steel's valuation looks intriguing. The stock is selling for a 3.2 price-to-earnings ratio (P/E), for one thing, which seems justified even by the meager 3.5% long-term growth that most analysts predict for the stock. But to my mind, the negatives outweigh the positives on this one. Namely:

• Over the past two years, free cash flow at U.S. Steel has greatly lagged reported GAAP profitability. Over the last 12 months, the company generated less than $800 million in free cash, even as it reported more than $1.4 billion in "net earnings."
• The dividend is rather anemic, at just a 0.5% yield.
• The company carries substantial debt -- $2 billion after you net out the cash.
• And did I mention the 3.5% growth rate?

Foolish takeaway
Call me a pessimist if you will, but I'm just not convinced that U.S. Steel is the best place to put your money right now. In a market as cheap as this one, there are better bargains out there ... and little need to settle for second-best.