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.

All Amazon, all the time
It's earnings season, Fools, and the bankers are flummoxed. Yesterday, Amazon.com (NASDAQ:AMZN) reported better-than-expected profits on slightly worse-than-expected sales -- and Wall Street doesn't know quite what to make of it.

• Over at Jefferies & Co., they're worrying that sales of books, CDs, and DVDs were "lackluster" last quarter. But Jefferies is impressed at the improved profit margins.
• Janney Montgomery Scott echoed Jefferies' concerns but says the stock was fairly valued (before this morning's selloff) and saw no reason to downgrade it.
• In contrast, Deutsche Bank was positively enthusiastic in observing that the company lowered prices on its products yet managed to expand its profits anyway.

But so far, only one analyst has actually gone so far as to change its rating on Amazon.com. That analyst, Collins Stewart, and that ratings downgrade, are the subjects of today's column.

Let's go to the tape
The first thing you need to know about Collins Stewart is that while it's the only analyst out there that's actively downgrading Amazon's stock, it's also the worst analyst of the four named above. Collins Stewart gets only about 46% of its recommendations right, overall, as tracked on CAPS. Yet I believe it's nevertheless quite likely right about Amazon no longer being a buy. Why? Well, consider Collins Stewart's record within a related industry segment to what Amazon inhabits -- Internet Software and Services:

Pretty impressive, huh? In fact, Collins Stewart has gotten better than 62% of its picks right when making predictions in this sector. (And I should also point out that the last time Collins Stewart assigned an affirmative rating to Amazon -- when it advised earlier this year that investors buy it -- the stock beat the market by 61 percentage points.)

Collins on Amazon
So after such a profitable run with the stock, why is Collins parting ways with Amazon today? In part it's because Collins sees a revival at eBay's (NASDAQ:EBAY) Marketplace posing a new threat to Amazon. But more importantly, after the run Amazon has taken, Collins simply no longer sees "material upside" in the stock. The analyst was willing to give Amazon the benefit of the doubt, as well as a chance to surprise us to that upside this week, but when Amazon failed to wow us, Collins decided to take its chips off the table and walk away a winner.

But should we listen?

I believe so. I think that at this point, Amazon's run really has run out -- and more importantly, I think Collins is right that the stock's no longer a buy. (Note, however, that the analyst only downgraded the stock to "hold," not all the way to "sell.")

Based on what we learned in this week's earnings report, Amazon is now generating free cash flow at the astounding rate of $1.5 billion per year. That's more than double what the company reported as net income over the same period, and an 89% improvement over a year ago ... but it still leaves the stock selling for 25 times its free cash flow.

Foolish takeaway
To me, that's not too unreasonable a price to pay for a company growing at the 22% annual clip that analysts expect from Amazon earnings. (And word to the Foolish -- Amazon's guidance for next quarter, at least, is right in line with what analysts are predicting.) However, I don't think the stock offers quite the bargain that it did back in April.

Considering that there remain numerous better bargains to choose from, I'd suggest putting Amazon on the back burner for now. Check back in a few months and see whether the price has improved a bit before you buy more.