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 worst ...
Nobody's saying Goldman Sachs is the world's best analyst (in fact, quite the contrary.) No one's saying Perfect World (Nasdaq: PWRD) is the perfect stock, either. But when you put the two together, it's starting to look like investors may have found a match made in heaven.

On Wednesday, Goldman initiated coverage of Chinese gamemaker Perfect World, and according to the analyst, this stock's a "buy." Delays in the release of three PW games have taken a chunk out of this Motley Fool Rule Breakers recommendation, but now that Forsaken World and Dragon Excalibur have been published, Goldman believes PW has overcome its difficulties, and "is back on track [toward] 15% non-GAAP EPADS growth in 2011."

Stop. Hold up a sec. "Non-GAAP EPADS?"
Sorry. Yes, Goldman does have a fondness for technospeak. So in English this time, Goldman is saying that Perfect World will grow its earnings per average diluted share (i.e. "EPADS") 15% in comparison to fiscal 2010's earnings -- provided you don't count niggling little details such as the cost of stock options, and any other costs Perfect World can convincingly pass off as "one-time" costs (i.e. "non-GAAP").

Once you work your way through Goldman's muddled verbiage, a pretty picture does emerge. This gaming software concern sells for barely 10 times earnings, while Activision Blizzard (Nasdaq: ATVI) costs 41 times earnings, and Electronic Arts (Nasdaq: ERTS) and Take-Two (Nasdaq: TTWO) both struggle even to earn anything. Better yet, Perfect World is likely to grow at 15%. That doesn't look like too shabby a value proposition, does it?

Let's go to the tape
Also attractive: Goldman's own record picking software winners. While it's a middling analyst overall, Goldman's been on a bit of a hot streak in the software sector lately, with recommendations on salesforce.com (NYSE: CRM), Oracle (Nasdaq: ORCL), and Perfect competitor Shanda Interactive (Nasdaq: SNDA) all outperforming the market:

Overall, Goldman's success rate in software stands at 60% for active picks. I think this week's Perfect pick will help push Goldman a little closer toward the goal of 100% perfection itself. Here's why:

Perfectly cheap
Personally, I'm no great fan of "non-GAAP" earnings. To me, these kinds of estimates often look like the old pro forma story in disguise -- inflated numbers, aiming to make companies' earnings appear prettier than they actually are.

But Goldman's actually giving us a conservative estimate for Perfect World, compared to the rest of Wall Street. According to Goldman, Perfect World will grow its "non-GAAP EPADS" in 2011. But elsewhere on Wall Street, the more common expectation is that after earning $2.60 per share this year, Perfect World will go on to earn $3.05 in 2011 -- which works out to 17% growth. (Longer term, expectations call for 14% annualized growth over the next five years.)

Whichever way you slice it -- 14% growth, or 15% or 17% -- we still seem to be looking at a sizeable discount on a 10 P/E stock. A stock that's lagged the market by a good 50 percentage points over the past year (and could be due for a bounce.) A company that, unlike so many we see on the market these days, produces high-quality earnings that often understate actual free cash flow in deference to GAAP accounting standards.

Perfect World: It may not be perfect, but it looks pretty good to me.