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 ...
Between its sizable "earnings beat" and an upgrade rolling in from Capital One Southcoast, Dril-Quip (NYSE: DRQ) shareholders are riding high.

I suppose I can see why Wall Street cottoned to Dril-Quip's results. The party line on this one seems to be that, once you back out non-recurring items, the offshore drilling equipment company's pro forma result of $0.74 in profits trumped Street expectations for $0.68. And yet, if you look at this from the perspective of GAAP earnings -- emphasis on the Generally Accepted part of these Accounting Principles -- Dril-Quip's $0.64 per share in Q1 profit actually exceeded last year's take by only a penny. So it was hardly a blowout quarter.

What's more, judging from the company's revelation that its backlog of work has dropped to just $550 million today from $573 million a year ago, well, it doesn't look like business is exactly going to boom in the future, either. But perhaps there's something in Capital One's upgrade that should tell us different, and give more hope for the future?

Speak up, Capital One
If there is, I don't know about it. And sadly, neither do you. Because while a few media outlets have reported the fact that the upgrade happened, none of the major reporting agencies seems to have any details on why, precisely, Capital One likes this one.

There are few situations more frustrating for the individual investor than seeing a major stock shop suddenly change its mind on a stock, yet give no reason why. And while we here at the Fool are just ordinary, individual investors like you, and have no special insight into Wall Street's opinion-making machine, we do have one thing to offer. We may not be able to tell you why Capital One thinks as it does about Dril-Quip ... but we can tell you how well it thinks.

Let's go to the tape
Namely, poorly. Almost exclusively an oil-stock picker by training, Capital One lives and dies by its reputation in the oil patch, with energy equipment and services and oil, gas and consumable fuels being its No. 1 and No. 2 coverage areas, respectively. Problem is, Capital One just plain doesn't do a very good job of picking oil stocks. Sixty-four percent of its picks in the equipment and services sector have underperformed the S&P 500, while 70% -- better than two out of three -- of its pure-play oil and gas plays have flopped. For instance:

Regrettably, I expect we'll see Dril-Quip take a similar trajectory to its companions in Capital One fandom. Namely, down.

Why? Because of the numbers. Consider: At its current valuation of 21 times earnings, Dril-Quip already looks plenty overvalued relative to peers like Cameron (NYSE: CAM), which trades at 17.2 times earnings. And while I'll grant you that Dril-Quip is growing faster than its larger rival, Wall Street expectations of 16% annual long-term earnings growth for Dril-Quip still don't add up to a buy thesis for me.

And that's the good news.

The bad news is that the deeper you drill into Dril-Quip's financials, the murkier the valuation proposition becomes. You see, while Dril-Quip claims to have earned $105 million over the past 12 months, its cash flow statements tell us a much different story. Over the past 12 months, Dril-Quip has struggled to generate even three-quarters as much cash as it claims to have earned as profits. Free cash flow for the period amounts to only $81.5 million, yielding a price-to-free cash flow ratio on this stock of just shy of 27.

Foolish takeaway
I know a lot of investors are getting excited right now by the sell-off in oil stocks in response to BP's (NYSE: BP)  "situation" down South. But just because it has "Southcoast" in its name doesn't mean that Capital One Southcoast has any better picture of where to drill for value in these waters than do you or I. To the contrary, its record proves to us that if anything, Capital One does a worse job picking oil stocks than anyone on the street with a coin to flip.

The way I see it: If you're looking for bargains, you'd best drill elsewhere. Capital One's opinions notwithstanding, Dril-Quip is just another dry hole.