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.

Sand gets in your eyes
It's earnings season on Wall Street, and the recommendations are coming in a flurry, as Wall Street's best and brightest try to position themselves to profit from big bumps while avoiding taking lumps from falling rocks. This week, all eyes are on Intel (Nasdaq: INTC) and its earnings report, due out this evening. With chips in focus, Deutsche Bank came out yesterday with a slew of new recommendations on how best to play tonight's news ... before it happens. Here's the lowdown.

According to Deutsche, the semiconductor sector posted 30% revenue growth last year and is due for a sophomore slump in 2011. The megabanker predicts just 5% overall revenue growth this year and suggests investors focus on finding the few pockets of undervaluation out there as they weather the brewing storm of disappointment. Deutsche says some of the best buys are Intel, Intersil (Nasdaq: ISIL), ON Semiconductor (Nasdaq: ONNN), Xilinx (Nasdaq: XLNX), and Monolithic Power. In contrast, Deutsche says it's time to cash in your chips on star NAND memory maker SanDisk (Nasdaq: SNDK) -- the subject of yesterday's downgrade, and today's column.

Let's go to the tape
So how do we know if Deutsche is right about the stocks it says are worth buying? How do we know it's right about SanDisk not being worth buying anymore? I humbly suggest that we can begin with a glance at Deutsche's record on these picks:

Company

 

Deutsche Said

CAPS Rating
(out of 5)

Deutsche's Picks Beating (Lagging) S&P by

ON Semiconductor Outperform **** 19 points
Intel Outperform **** 14 points
Monolithic Power Outperform **** 5 points
Xilinx Outperform ** (14 points) (picked twice)
Intersil Outperform **** (37 points)

It would appear Deutsche's record here is a bit on the spotty side. (If you want to take a look at Deutsche's full scorecard, it's even worse than what I've laid out above; over the past year, a whopping 53% of Deutsche's semiconductor stock recommendations have failed to even match the market's returns.) Which brings us to today's recommendation: the downgrade on SanDisk.

You see, according to Deutsche, SanDisk is no longer a buy because it's business is going too well. Tablet PCs such as Apple's near-ubiquitous iPad and the slew of Android also-rans are set to take off in 2011. This is driving demand for NAND memory packages (such as SanDisk produces), sparking an increase in production capacity across the industry, and promising to "sharply" reduce NAND prices. (Now where have I heard that before ... ?)

Consequently, Deutsche says, it's time to step out of SanDisk for the time being, while we wait to see where NAND prices settle down, and how far SanDisk's profit margins are going to get squeezed. But me, I think that's exactly the wrong call to make.

Buy these numbers
When I look at the valuation on SanDisk today, I see a large margin of safety protecting you from the risk that NAND prices drop more than new sales can make up for (the "we'll make it up on volume" argument). Conversely, if SanDisk manages to make a decent profit margin on the NAND it sells and sells more NAND to its customers, the profits could simply astound. Consider: With $1.4 billion in trailing free cash flow and nearly $1.2 billion in GAAP earnings, SanDisk shares sell for less than nine times free cash flow, and less than 11 times earnings. Against these modest valuations, most analysts on Wall Street predict we will see profit growth in excess of 14% per year over the next five years at SanDisk.

Incidentally, the company has exceeded similar estimates in each of the past four quarters. To my mind, a continuation of SanDisk's winning ways -- or even a more modest pacing of consensus expectations -- gives us very attractive valuations on the shares today. More than enough to protect us on the downside; with plenty of reason to hope for upside appreciation in the shares.

Foolish final thought
I should also mention that even in the course of downgrading the stock, Deutsche itself seems optimistic about the company's chances. Deutsche left both its sales and earnings predictions intact for SanDisk, while actually raising its target price! Meanwhile, Deutsche peers Baird and Sterne Agee made similarly bullish noises about SanDisk competitor Micron (NYSE: MU) this morning.

We'll take a look at new buy ratings tomorrow, but for now I think it's safe to say: A lot of folks recognize the value in NAND memory makers like SanDisk; it's just a pity that Deutsche seems to have forgotten it.

Rich Smith does not own shares of, nor is he short, any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 739 out of more than 170,000 members. The Motley Fool has a disclosure policy.

Xilinx is a Motley Fool Big Short short-sale choice and Motley Fool Alpha has opened a short position on Xilinx. Intel is a Motley Fool Inside Value recommendation and Motley Fool Options has recommended buying calls on Intel. Apple is a Motley Fool Stock Advisor recommendation and The Fool owns shares of Apple.

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