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'll 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.

AMD or Intel?
For most computer users, I imagine, it doesn't matter much whether their PC has "Intel (Nasdaq: INTC) Inside" or packs chips from Advanced Micro Devices (NYSE: AMD). So long as the email comes through all right, and it doesn't take too long to boot up "Angry Birds," it's all good.

Among computer techies, and stock analysts, however, there's an ongoing and heated debate about which semiconductor firm is better. In that debate, FBR Capital just switched sides. Formerly an advocate of Intel, FBR announced yesterday it's throwing its support behind AMD instead.

Pushing Intel to the side
Not that FBR hates Intel. To the contrary, FBR praises the company's "scale" of operations, and its "manufacturing and costs advantages" over AMD. Yet for some reason, FBR seems convinced the stock will face "herculean difficulties" rising above $24 a share. (Which seems strange, considering this would require only a 12% rise in price, and that the stock market tends to grow nearly that much annually over time.)

Regardless, the analyst sees more promise in AMD today. FBR highlights AMD's success in getting its chips into Hewlett-Packard (NYSE: HPQ) and Acer notebooks and desktops. FBR further believes that AMD's Fusion chip will price 10% to 15% below the cost of comparable Intel chips. This could translate into improved market share for AMD, and perhaps "40-60 cents a share" in additional profits. But is that enough to justify picking AMD over Intel?

Let's go to the tape
I have my doubts. Nor does FBR's record-to-date in the semiconductor industry reassure me:

FBR spends a lot of time studying the semiconductor industry, publishing 51 picks here over the last five years. Sadly, the effort doesn't seem to be paying off. FBR's gotten AMD right two times out of three so far, and its (now-ended) 2006 Intel pick beat the market handily. But the majority of FBR's chip-picks have gone south. Overall, the analyst's semi-recommendations have lagged the S&P 500 by a combined 350 percentage points.

And I'm afraid it's making two more mistakes this week.

Valuation matters
Don't get me wrong. I actually agree with FBR on its revocation of Intel's buy-rating. Sure, the stock certainly looks cheap at 10 times earnings. On its face, that appears to offer a discount to other, pricier semi-stocks such as NVIDIA, Silicon Labs, and ARM Holdings (Nasdaq: ARMH), all of which boast P/Es in the 30s. However, a review of Intel's cash flow statement suggests its "earnings" aren't all they're cracked up to be. Earlier this year, you see, Intel told us it planned to drastically increase its spending on capex in 2011.

Already, we're seeing the effects. Free cash flow for the past 12 months backs up less than 80% of Intel's reported "net income." At a price-to-free cash flow ratio of 11.8, about the best I can say about Intel today is that it looks fairly priced -- but will look ever more expensive as the year progresses and Intel's capex eats into free cash flow.

But is AMD really any better -- or more worthy of FBR's outperform rating? I'd argue not. Again, the GAAP numbers on this stock look good (helped by a big litigation payment from Intel, AMD turned GAAP-profitable in 2009, improved its profits in 2010, and is still growing). But again, the free cash flow tells a different tale. After eking out a small free cash gain in 2009, AMD quickly dipped back into the red in 2010. Over the past 12 months, cash burn has accelerated to the point where AMD's now burning more than $740 million annually.

Foolish final thought
So, is AMD a better bet than Intel, like FBR says? Maybe. On the other hand, as FBR also says, maybe Intel will simply crush the competition with more aggressive pricing, destroying the buy thesis for AMD. Either way, I see no compelling need to own either Intel or AMD until one of these companies demonstrates an ability to grow its free cash flow.

For the time being, I'd rather own a computer maker like Apple (Nasdaq: AAPL), which benefits from the chip-rivals' ceaseless price wars ... and is throwing off monster free cash flow to boot.