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 …
Once, I was right about DreamWorks Animation (NYSE: DWA) being overpriced. The second time, too. But as DreamWorks' shares continue their tumble from north of $40 to under $30, is now the time to call a halt to the decline? At least one analyst thinks it is -- and what an analyst it is.

On Wednesday, one of the very best investors in the business, Stifel Nicolaus, waded into Shrek's swamp and cast DreamWorks a lifeline. Citing the stock's 35% drop in just a few weeks of trading as evidence that "Wall Street underestimates prospects for its slate of upcoming films," Stifel upgraded the shares to "buy" yesterday. Why?

Dragons and ogres and bears -- oh, my!
On the one hand, Goldman Sachs (NYSE: GS) blasted the shares last week for failing to produce a sufficiently boffo box office on Shrek 4. Although the domestic take has already topped $200 million, Goldman thinks traffic is starting to peter out and will struggle to reach $250 million, down from its earlier hoped-for $325 million. And maybe Goldman's right -- but that's not the point.

According to Stifel, the point is that How to Train Your Dragon produced more money than expected, and that whatever Shrek's domestic box turns out to be, its global revenues could still "contribute meaningfully to revenue" as the film opens for viewing in more and more countries. Then, farther out, Stifel sees the potential for an earnings surprise if the underwhelming critical response to DreamWorks' next big thing, Megamind, is belied by a better-than-expected box office. In other words: DreamWorks is more than just a one-trick ogre.

Let's go to the tape
Why is this important? Why should we care a whit what Stifel thinks, when the illustrious Goldman Sachs disagrees with it? Because -- not to put too fine a point on it -- when it comes to picking successful stocks, Stifel's a genius, and Goldman's a goat. Years of tracking each analyst's performance have Stifel scoring in the top 3% of investors, globally -- while Goldman languishes somewhere in the bottom 20%.

Now, detractors may point out that Stifel's record in the Media sector is somewhat less than stellar. While beating the market overall, only 45% of Stifel's picks are outperforming, individually. And yes, Stifel has made its share of mistakes: 

However, Stifel's biggest blunders in media have little to nothing to do with filmed entertainment. While admittedly part of the media sector, Sirius is a satellite-radio star, nothing more, nothing less. CBS considers cable and broadcast television its stomping grounds, while even News Corp -- of 20th Century Fox fame -- garners only 20% of its annual revenues from the movie biz. None of these are anywhere near the pure play on the silver screen that DreamWorks is.

And by the way, would you like to know how Stifel did the last time it picked DreamWorks to outperform, in 2007? It beat the market by 24 percentage points, that's what happened. And while I'm still not 100% convinced of the rightness of this week's call, I do finally see merit in the bull thesis for DreamWorks. Here's why.

Hollywood accounting
On the face of it, DreamWorks looks (almost) as overvalued as ever. The stock sells for nearly 23 times earnings, and with cash generation at cyclically low levels, for nearly 50 times free cash flow. That said, moviemaking is a notoriously boom-and-bust business -- one day you're making Ishtar, the next day, Avatar. To account for the lumpiness, and give DreamWorks bulls the benefit of the doubt, I'm going to run a quick check on DreamWorks' valuation, using its results over the past five years as my starting point.

Viewed from that vantage, we find that over the past half-decade, DreamWorks has generated $174 million in free cash flow per year on average, reporting $126 million of this as its "net profit." At today's price, the company therefore trades for about 20 times its average annual income, or 14.5 times average free cash flow.Now, I can't say these numbers exactly scream "cheap!" just yet. But relative to analysts' consensus that

DreamWorks will grow at just under 17% per year over the next five years, I'd say the stock is finally approaching fair value -- and may even be worth buying.

Foolish final thought
Mind you, I still see greater value in DreamWorks rival Disney (NYSE: DIS), which:

• Sells for a cheaper P/E ratio of 18.
• Boasts incredibly high "earnings quality," inasmuch as its free cash flow more than equals its reported income.
• Can be expected to benefit in its theme-park operations from the "Hey, what do we do in Florida now that all the beaches are black?" effect.

Given my druthers, I'd be using my spare cash to buy Disney stock today. That said, I'd no longer be selling DreamWorks shares to raise the necessary cash. DreamWorks, at long last, has finally hit bottom.