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.

This little banker went to market ...
Chalk it up to my being a parent of small children, but as I reviewed Wall Street's latest batch of upgrades, downgrades, and initiations yesterday evening, a nursery rhyme ran through my brain. (And if this metaphor gets a bit mangled, chalk that up to the sleep-deprived state of all parents of small children.)

Susquehanna Financial went to market yesterday -- or more precisely, visited various stock markets across the land, and handed out new ratings to each. Which of these little piggies got roast beef, and which of 'em got none? That's today's story.

CME Group
The lucky, beef-fed winner of this industry (in Susquehanna's estimation) is CME Group (NYSE:CME). Praising its: "defensible market position, solid earnings and free cash flow growth capabilities," Susquehanna rates this stock "positive." The banker especially likes Chicago Merc's "95% market share in the U.S. futures industry ... which we believe will enter another bull market when the U.S. central bank comes off its liquidity programs." As an added bonus, Susquehanna notes that the company "owns 4.8% of the largest exchange in Brazil," and will soon begin "overnight trading in the Kospi 200 futures contract from the Korea Exchange."

But if Susquehanna thinks CME's good eatin', it finds CME's rival exchanges less appetizing:

• NYSE Euronext (NYSE:NYX): Susquehanna thinks NYSE will underperform its peers as "equity tape volume growth in 2009" falls short of expectations, leading to missed earnings estimates.
• Nasdaq OMX (NASDAQ:NDAQ): Likewise, Susquehanna's of the opinion that "cash equity trading" has run abnormally high at Nasdaq "due to the credit crisis during the past year." (Because panic begets frantic trading.) Susquehanna sees trading volumes and value picking up in Europe, mitigating the damage from a U.S. slowdown. Regardless, the banker fears we will see "lower than consensus estimates" in 2010.
• InterContinental Exchange (NYSE:ICE): Last, but far from least, comes the ICE. Susquehanna loves its "diverse revenue stream" and calls the firm "well managed." Over the long term, the banker predicts "continued weakness in the U.S. dollar [will lead to] continued investment into the commodity sector and foreign stocks ... to hedge U.S. currency exposure." Yet despite all the pluses, Susquehanna says it's still "waiting for the right entry point."

Tell us what you really think, Susquehanna
To my mind, that's a gentle way of saying: "InterContinental Exchange costs too durn much" -- and with ICE trading for a 27 P/E, it's hard to argue with that assessment. Likewise, I see a lot of logic in Susquehanna's panning of NYSE Euronext. Profitless and generating minimal free cash flow ($113 million over the last 12 months), I see little prospect for profit in that stock, either.

To me, ICE and NYSE both seem like obvious calls -- valuation-based recommendations that even Susquehanna could make. Where I break with Susquehanna is on the trickier picks, the ones where even a savvy software analyst like Susquehanna could run afoul, since it lacks much experience in the financial sector (remember that all four of this week's ratings are "initiations" of coverage).

To my Foolish value-seeking eye, I can see why Susquehanna thinks CME has some attraction, inasmuch as its GAAP numbers understate true cash profitability; free cash flow at the company currently runs 42% ahead of reported earnings. But with the P/E sitting at 30, and only 13% long-term growth projected, the stock's valuation still looks stretched to me.

The best stock of the markets
Or consider Susquehanna's negative note on Nasdaq. Of the four "stock exchanges" it reviewed yesterday, I like Nasdaq best.

The stock sports an attractive PEG ratio based on its 16 P/E and 15% projected long-term growth. And while detractors will point out that Nasdaq carries a sizeable debt load, I'd reply that for a $4.1 billion concern like Nasdaq, the firm's $1.6 billion net indebtedness does little to affect the valuation picture. Thanks to copious generation of free cash, Nasdaq boasts an enterprise value-to-free cash flow ratio of less than 17 -- meaning the stock is only slightly more expensive than its P/E makes it appear.

Foolish takeaway
Now, I'm not saying Nasdaq is a screaming buy -- it's not. There are better values out there if you know where to look. But within the tiny market of the four stock exchanges Susquehanna is focusing on this week, Nasdaq's the clear winner.

And CME? Sorry, shareholders, but I wouldn't follow Susquehanna's lead on that one. Seems to me that CME's a pig in a poke.