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." While the pinstripe-and-wingtip crowd is entitled to its opinions, we've got some pretty sharp stock pickers down here on Main Street, too. (And we're not always impressed with how Wall Street does its job.)

Given that, perhaps we shouldn't be giving virtual ink to "news" of analyst upgrades and downgrades. And we wouldn't -- if that were all we were doing. Fortunately, in "This Just In," we don't simply tell you what the analysts said. We 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.

Tell me why
I've got good news and bad news for investor in Chipotle Mexican Grill (NYSE: CMG). Good news first: Just this morning, one of the sharpest stock pickers in the business upgraded your stock. The bad news: No one's buying the upgrade, and no one seems to know why it happened.

There are few things more frustrating for the individual investor than knowing some Wall Street hot shot has changed his or her mind on your stock, but not knowing the reason. That's why today's change of heart is so disheartening. We know that Morgan Keegan has removed its "sell" rating on Chipotle, but we don't know why. The closest thing the mainstream press gets to providing an explanation for Morgan's move is a throwaway line in TheStreet.com's mention of the upgrade, that it's a "valuation call." (Strangely, though, at $237 and change, the stock doesn't look like much of a bargain.)

Let's go to the tape
But don't lose heart, dear Fool. While I can't tell you why Morgan Keegan has changed its opinion of Chipotle, I can tell you how successful the analyst's been in making similar calls in the past -- thanks to Motley Fool CAPS.

We've been tracking Morgan Keegan's performance on picking restaurant stocks for nigh on five years now, you see. Unfortunately, what we've discovered is that this analyst is about as accurate as a burger-flip when it comes to picking winning restaurateurs. Over the years, MK's been right about Buffalo Wild Wings (Nasdaq: BWLD), for example (three times in a row!), but wrong about Sonic (Nasdaq: SONC). Very right about Panera Bread (Nasdaq: PNRA), but considerably less so about California Pizza Kitchen (Nasdaq: CPKI):

No offense to Morgan Keegan, but with a record as hit-or-miss as this one, I'm simply not comfortable taking the analyst's say-so as a good enough reason to buy the stock. Lacking a clear record of success in the industry, Foolish investors have to demand more details to go on. So let's do some digging.

Reviewing MK's restaurant list, it gets pretty clear, pretty quickly that this analyst is focusing its efforts on small fry. We're not talking McDonald's or Starbucks here, folks. Not a one of these restaurant chains has yet broken $2 billion in annual sales. Most have yet to see their first billion-buck year. They're still in all-out growth mode.

Valuation matters
And that's what makes today's Chipotle choice so very interesting. Ordinarily, when a restaurateur is in go-go growth mode and spending tons of cash to build new sandwich shops, its accountants are telling it to go ahead, report lots of profits and depreciate the cost of opening those new shops. Ordinarily, though, during this stage of its lifespan, the restaurant's cash flow statements contradict this story -- and show the restaurant is actually burning cash at a frenetic pace.

But Chipotle is anything but ordinary. Based on its most recent financial statements, the company reported earning $179 million last year -- but its actual free cash flow was nearly as strong: $176 million. I shudder (with greed) to think what Chipotle's cash haul might look like if the company weren't in the midst of a 140-restaurant annual building binge.

Foolish takeaway
We don't know exactly why Morgan Keegan reversed a sell rating on Chipotle after less than a month. But I can tell you why that might be the right call to make anyway: The simple facts that this stock costs 42 times earnings and is growing at "only" 20% per year don't come close to telling the true story of Chipotle's value. This stock is a whole lot cheaper than it looks.