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.

When Deutsche speaks …
An upgrade from Deutsche Securities wasn't enough to save Dolby Labs (NYSE: DLB) from yesterday's market hiccup. But now that Mr. Market's found his footing again, Dolby shares are climbing back toward $61 territory. (And incidentally, are up about 13% since I predicted this rise two weeks ago.)

Why the quick rebound? Well, let's take a look at what Deutsche had to say yesterday. According to the analyst, Dolby's recent share price weakness can be traced back to three key sources:

• Slowing sales of flat-panel televisions and personal computers.
• Fears that Apple's (Nasdaq: AAPL) iPad sales are cannibalizing sales of PCs incorporating Dolby's technology, and perhaps fears that future tablet computer offerings from Research In Motion (Nasdaq: RIMM), Hewlett-Packard (NYSE: HPQ), Cisco (Nasdaq: CSCO), and others will further eat into sales.
• A general long-term trend of declining DVD sales, resulting in declining DVD player sales, as home movie-viewing migrates from shiny discs to streaming video.

Each of these trends threatens Dolby's business, inasmuch as the company depends on strong hardware sales to drive its own sales of audio technology incorporated into said hardware. Fortunately, Deutsche believes these fears are overblown.

Even more fortunately, Deutsche tells us that until investors realize that the risks have been overrated, there's a buying opportunity at Dolby: "The bottom-line is that Dolby has exceeded expectations for over 4 straight years and every once in a while, a buying opportunity exists ... We think this is one of them and that growth remains robust," wrote the analyst.

Let's go to the tape
My Foolish colleague Rich Duprey said much the same thing last week, when he named Dolby Labs one of 10 stocks you can put in your portfolio forever. But is Rich right about that? Is Deutsche?

Much as I wish I could tell you this is a slam dunk … it isn't, for several reasons. Let's start with the record of today's rater:

Deutsche may rank as one of the top analysts we track on CAPS generally (the banker scores in the top 10% of CAPS players), but its record on electronic equipment stocks like Dolby is mediocre at best. Historically, fewer than 50% of Deutsche's picks in this industry have outperformed the market, and the banker is flubbing some of its other recommendations pretty badly:

So when Deutsche tells us today that Dolby will bounce right back from its drop on "strong results" in fiscal Q4, a ramp-up in sales of Chinese television sets incorporating Dolby technology, and widescale adoption of Windows 7-with-Dolby, well ... I'm not saying Deutsche is necessarily wrong about these things, but on the other hand, I'm not convinced they make the stock a "buy" either.

When I argued that Dolby was attractively priced and due for a bounce earlier this month, I added the caveat that the stock wasn't a "screaming bargain." And while it's gratifying to see that I was right, and good to know that investors who bought Dolby at the time are now sitting atop a sizable profit, there's also a downside to the rise in stock price. Namely, the stock that was no screamer two weeks ago has been struck with laryngitis today.

Selling for nearly 27 times earnings and more than 22 times free cash flow, Dolby is priced at a premium to projections of sub-16% long-term earnings growth. Even if -- as Rich Duprey and Deutsche both point out -- the company continues to produce numbers stronger than analysts expect, it's going to be hard-pressed to outperform as strongly as necessary to justify today's stock price.

Foolish takeaway
Winning supersized profits in the stock market is very much a function of buying shares when they're cheap, and selling when they approach fair value. Instead of this rational approach, however, Deutsche Securities seems to be urging investors to buy Dolby when it's priced for perfection.

The problem with that, though, is this: If everything goes perfectly, you've got yourself some fairly valued Dolby shares, and congratulations to you. But if anything goes wrong (and something always does), look out below.