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.

"Give 'em an inch, they'll take a mile ... "
And apparently, if you give Wall Street three-plus days to ruminate, they'll produce 77 separate opinions. As the trading week opened Monday, Wall Street opened the floodgates on its opinion makers: 44 upgrades, 22 downgrades, and 11 initiations of new coverage roared forth over the course of the trading day -- and that's just the announcements that Briefing.com managed to catch. With so much new data coursing over the wires, I imagine Briefing must have missed a few data points ...

In fact, I know it did, because one of the ones it missed is today's top story: Broadpoint.Amtech's surprise downgrade of NVIDIA (NASDAQ:NVDA) Monday. Citing a slew of problems with the stock -- potential share-loss in the GPU market, weak 40 nanometer yields, rising operating costs, and a probable decline in chipset sales in the second half of 2010 -- Broadpoint declared: "the risk/reward ... unfavorable," and recommended that investors sell the stock.

And it's right.

Sell NVIDIA? Are you crazy?!
I know, I know. It's a Motley Fool Stock Advisor recommendation. I write for the Fool. I'm supposed to love the stock, right? Well, I don't, and here's why: First and foremost, consider Broadpoint's record in the chip-o-sphere. While broadly speaking, Broadpoint's only a middling analyst of 48% accuracy on most its guesses, lately, the banker's been setting the silicon world on fire:

62% of Broadpoint's active picks in the sector are beating the market, a remarkable record on Wall Street. So when Broadpoint expresses dismay over "the market's willingness to pay 18-20x P/E multiples using pro forma estimates for GPU assets when rapid and significant share shifts occur regularly," investors might want to take that as their cue to re-examine assumptions about NVIDIA.

The pros
Granted, NVIDIA has a lot to recommend it. The company recently resumed producing positive free cash flow. It booked its first GAAP profit in over a year last quarter. And with $1.6 billion cash and almost no debt to its name, the company's balance sheet looks plenty strong to support further expansion.

The cons
But now that the stock's doubled over the past 12 months, do all these facts suffice to justify the current valuation? As Broadpoint points out, NVIDIA shares now command a valuation of nearly 20 times pro forma estimates. They're also trading for more than 50 times this year's projected GAAP earnings, 24 times next year's GAAP, and 34 times trailing free cash flow. Call me a pessimist, but that seems like an awful lot of double-digit multiples investors are piling on the back of a stock expected to grow only 13.4% per year over the next few years.

Consider too that even this growth rate looks optimistic, seeing as it's faster than: (a) the rate for the semiconductor industry as a whole, (b) the pace Intel is expected to set, and (c) nearly twice the rate for archrival AMD. And even if you believe NVIDIA is the growth leader today, Broadpoint's concerns about "rapid and significant share shifts" should give us all pause about predicting continued good fortune for NVIDIA tomorrow.

Foolish takeaway
Sure, maybe everything will go right for NVIDIA over the next few years ... in which case the shares still look overvalued. And if anything goes wrong -- and I do mean anything: loss of market share, higher than expected operating expenses, any of the multiple risk factors Broadpoint laid out for us -- this will cause the shares to look even more overvalued.

And ripe to fall.