This Just In: Visa and MasterCard Downgrade?

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 …
Mr. Buffett may be certain we'll avoid a double-dip into recession (and he repeated the assertion this morning), but Mr. Market seems less certain. Markets are opening down across the country, and over at Wall Street investment house Sanford Bernstein, the analysts just got finished downgrading Visa (NYSE: V) and MasterCard (NYSE: MA) on fears that more government meddling in the markets will crimp profits in the banking sector.

In a research note released yesterday, Bernstein pummeled the plastic pushers with warnings of negative sentiment among investors, greater pricing pressure on their "PIN debit business" in the U.S., and a threatened permanent kibosh on higher interchange fees in Europe. Opined Bernstein: "even if regulators allow price increases, it may not be prudent for V and MA to pursue them, given the chance for backlash in the form of more regulation or litigation."

In which case, the 30%-and-greater growth rates these companies have historically produced could become just that: history.

Let's go to the tape
Investors reacted sharply to the news of Bernstein's sudden reversal (up until yesterday, the banker had been consistently bullish on both Visa and MasterCard), bidding down shares of both companies yesterday. But truly, the surprising thing here isn't that Bernstein has turned negative on the stocks -- it's that the analyst ever saw anything positive in these companies in the first place.

Or maybe that's not so surprising, considering Bernstein's record: 

After more than four years following the ups and downs of Bernstein's ratings fortune, I can come to only one conclusion today: This banker is truly miserable at picking banking stocks.

Over the years, Bernstein's been wrong about Visa and MasterCard. Wrong on its consumer finance picks. It's gotten a handful of commercial banking recommendations right, but its recommendations are no better than a coin flip there, either. With a record like this, Bernstein had no business telling investors to buy MasterCard and Visa in the first place. Especially when you consider the numbers:

Now granted, I see how Bernstein could have concluded that these companies were "buys" based on their P/E ratios alone. At 15 times earnings, and 18% long-term growth projected for it, MasterCard looks cheap even today. Likewise Visa, at its 18 P/E and 20% growth. But come on folks. It doesn't take much digging to see that these companies' "profits" are largely illusory, and lacking in the cash-generating power needed to back them up.

Foolish takeaway
With MasterCard at more than 25 times free cash flow, and Visa at a whopping 37 times FCF, this analyst really should have known better than to go hawking these equities to investors. But the truth is actually opposite -- even after yesterday's downgrades, Bernstein is still urging investors to hold onto the stocks (which it now rates "market perform," not even "market underperform").

Why Bernstein picked this pair of flops, when there's a bona fide bargain staring it in the face at American Express (NYSE: AXP) -- where free cash flow comes in at more than twice reported earnings, and the price-to-free cash flow ratio is a mere 6.5 -- is beyond me. I guess the real lesson of this week's ratings is this: Even a respected analyst can fall into a value trap … twice.

Just don't you make the same mistake.