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." Today, we're going to try and show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

And speaking of the best ...
Yesterday, I told you how, despite manifold reservations about the manner in which General Electric (NYSE: GE) improved its profits last week, I still liked the stock. Turns out, I'm not alone -- because at the very moment I was penning my opinion, up on Wall Street one of the very best investors on the planet was saying much the same thing.

The investor in question: Investment banker Sterne Agee, which yesterday clambered out on a limb and argued that even if everyone is intent on selling GE, Sterne believes it's actually a "buy." Here's why:

Sterne Agee: It brings good bargains to light
GE's earnings report last week painted a portrait of a company wherein GE Capital does the heavy lifting, tripling its profits and helping the company to beat estimates. Meanwhile, industrial operations played second fiddle, and the company's energy business in particular proved a drag on results. And yet it's these very industrial businesses that Sterne finds attractive. While Sterne's as impressed as the rest of us over the "upswing" at GE Capital, what really gets the analyst excited is: "order trends, renewed investment in new products through higher R&D ... and focus on achieving consistent high teens operating margins" at GE's industrial businesses.

According to Sterne, these factors combine to "warrant a rethink as to the normalized earnings power of the Industrial arm of the company." The analyst believes GE could be regularly reporting profits of $2 to $2.50 per year by 2013 (roughly twice the level of profitability today,) and paying shareholders a dividend of $0.82 per share or more (about a third better than the current yield.) Could it be true?

Let's go to the tape
Actually, yes. If Sterne Agee's record is any indication, it could all be true. Because when it comes to picking winners in the industrial conglomerate industry, there are few investors on the planet with a record to match Sterne's.

Over the several years we've been tracking this analyst, Sterne has made only a handful of picks in the industry (not surprising -- by definition, there's only room on the planet for a handful of truly gigantic "industrial conglomerates.") And yet, Sterne has gotten nearly every pick it's made in the industry right:

Fact is, the only pick Sterne's made one mistake in the IC industry so far: 3M (NYSE: MMM) -- and even that recommendation came within a single percentage point of outperforming the market. In short, if you're going to take any analyst's advice on how to play GE, Sterne Agee is probably the one you want to listen to.

Caveats, wherefores, and provisos
Sterne's record notwithstanding, I understand why some investors might be questioning the wisdom of investing in GE right now. The company does have a spotty record of performance, and depending on consistent profits from GE Capital has been a losing bet of late.

There's also the valuation to consider. At nearly 19 times trailing earnings, GE costs more than either 3M or Tyco, despite being marked for a similar growth rate. On the other hand, it's got a lower P/E ratio than either McDermott or Siemens.

Perhaps most telling is the fact that GE sells for sizeable discounts to several of the energy companies it's been challenging with its recent spate of acquisitions in the energy services industry. Compare GE's P/E to those of Schlumberger (NYSE: SLB) or Halliburton (NYSE: HAL) for example, and you'll find Mr. Lightbulb costs about 25% less than its new peers. Recent rival Baker Hughes (NYSE: BHI) casts an even bigger shadow. At 35.8 times earnings, BH bears a valuation fully 90% higher than GE (albeit, it's also pegged for twice-as-fast growth.)

Foolish final thought
And this is where Sterne Agee's advice really gets interesting. According to the analyst, GE is going to blow right past the 12% annual growth estimates that most analysts have assigned it, and literally double its earnings over the course of the next three years. If Sterne is right -- and its record suggests it may well be -- then GE is selling for much, much less than it's worth today. Instead of a 19 P/E, it might actually deserve a valuation similar to the one Baker Hughes now boasts.

And that, dear Fool, would bring good things to GE investors' lives.