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 ...
It's hard out there for a gamer. On Monday, market researcher NPD Group reported that September sales of video game hardware, software, and accessories eked out a bare 1% increase over last year's levels. This fell far short of the 10% and 20% numbers that Wall Street had projected, and a disappointed Street took out its frustration on shares of gaming specialist GameStop (NYSE:GME).

Citing weak sales and diminished "new product foot traffic," Janney Montgomery Scott pulled its buy rating on the stock yesterday. According to Janney, the fact that console cost-cuts by Microsoft (NASDAQ:MSFT), Nintendo, and Sony have failed to spark sales growth raises concerns "about the health of the gaming cycle and [GameStop's] need to discount used product to compensate for the lack of new product."

Janney thinks we'll see companywide sales decline 4% in the fiscal third quarter, and so is going "neutral" on the shares. (Meanwhile, taking a page from the contrarian playbook, rival analyst RBC Capital Markets just initiated coverage of shares of key GameStop suppliers Activision Blizzard (NASDAQ:ATVI) and Electronic Arts (NASDAQ:ERTS) at "outperform" -- so go figure.)

Let's go to the tape
Is Janney's move a disappointment for GameStop investors? No doubt. But here's the good news: When it comes to retail, Janney's a perfectly awful analyst:

Now I should point out that Janney's not so bad across the board. In fact, the company is beating the market with bullish picks like Activision Blizzard (Hi, RBC!) and TiVo (NASDAQ:TIVO), and indeed, 70% of Janney's recs in the software space are outperforming.

But its skill upstream notwithstanding, the firm just doesn't seem to have a good grasp of the downstream retail sector. Of the nine recommendations Janney has made here over the last three years, fewer than half have managed to edge out the S&P's returns. And as far as this week's GameStop downgrade goes ... well, I think it's fair to ask why should we listen to an analyst who's already underperformed the market by 30 percentage points on the stock?

Answer: You shouldn't
Fools, Janney is dead wrong on GameStop -- not the sales decline, necessarily. I actually think Janney might be right about that. Between the ongoing recession and a dearth of hot software titles to draw shoppers into the store, it's entirely possible that GameStop's sales will slip in the next quarter.

But so what? Here at the Fool, we don't invest in companies for one month's results. We invest for the long haul. And over that long haul, I see great prospects for GameStop.

Valuation-wise, the stock sells for just a little over 11 times earnings, and about 13.3 times free cash flow. That's not the biggest discount relative to its growth prospects that I've ever seen, but it looks like at least a fair price. And this is especially true when you consider the breadth of this company's moat. GameStop dominates the field of gaming retail -- and secures its position against the online-download threat by offering its customers exclusive freebies (new "levels," special-access weapons not available online, and so on).

Meanwhile, GameStop's used-game business is tailor-made to capitalize on cash-strapped consumers and an economy in recession. And while it's true that Amazon has moved to capture a piece of the action here, what I'm hearing (anecdotally, at least), is that gamers are not taking the bait. (Note to management: privately owned GameFly, however, does seem to be making headway -- might want to consider buying 'em and getting that fly out of your ointment.)

Foolish takeaway
As the dominant player in a unique niche of the retailing world, and one that shows a flair for defending its business model against all comers, GameStop can't be beat -- least of all by one short-sighted downgrade. Game on!