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.

Joy returns to Mudville
We'll get into this morning's rating in a moment. But first, a few phrases to set the mood:

"Oh, somewhere in this favored land the sun is shining bright;
The band is playing somewhere, and somewhere hearts are light,
And somewhere men are laughing, and somewhere children shout;
But there is no joy in Mudville — mighty Casey has struck out."

It's been more than a century since Ernest Thayer penned Casey at the Bat. A long time to wait, but this week, "joy" returned to Mudville as Goldman Sachs stepped to the plate and recommended a purchase of professional mud-digger Joy Global (Nasdaq: JOYG). According to Goldman, a reviving global economy and strong demand for natural resources have done wonders for the fortunes of iron miners like Rio Tinto (NYSE: RIO), Vale (Nasdaq: VALE), and BHP Billiton (NYSE: BHP).

Problem is, miners today are struggling to extract profit from "declining mine ore grades." Simply put, they've got to move more dirt to find each incremental kilo of iron ore. This creates an opportunity for Joy Global and rivals Terex (NYSE: TEX), Bucyrus (Nasdaq: BUCY), and Caterpillar (NYSE: CAT) to capitalize on the growing need for mining equipment. Moreover, Goldman says investors "drastically" underestimate Joy's ability to sell aftermarket parts for its equipment -- and are undervaluing the company by about 25% as a result.

I agree.

Let's go to the tape
There are several reasons for thinking Goldman is right in its joyous valuation of Joy. Let's begin with the analyst's track record on similar stocks in the machinery industry:

Over the two years we've been tracking Goldman's performance, this analyst has gotten the majority of its machinery picks right, beating the market by 119 percentage points in aggregate (about nine points per pick). Goldman has been particularly successful with Joy Global, racking up about 64 points of market outperformance on its last-reported recommendation of the stock.

Joy Global: Buy the numbers
Valuation-wise, Joy looks like another winner for Goldman. Relative to its peers, Joy boasts a lower P/E ratio than either Terex or Bucyrus, and is about on par with Caterpillar. Analysts also have it pegged for faster earnings growth than any of its peers, with the sole exception of -- you guessed it -- Caterpillar again. (Hmm. Maybe Goldman should be looking at making another upgrade ... )

Joy looks no less attractive when viewed in isolation. At barely 19 times earnings, the stock today looks no worse than fairly priced based on consensus estimates of 18.5% long-term earnings growth. If Goldman's right about these estimates being conservative, the stock could easily rise in value.

Foolish final thought
Indeed, you could argue that even without the benefit of an "earnings surprise," the stock is cheap. Data from Capital IQ, a division of Standard & Poor's, suggest that Joy Global's reported earnings may actually understate Joy's true level of profitability. Free cash flow for the past 12 months has exceeded reported GAAP income by about 7.5%.

With $570 million in annual free cash flow to its credit, and a balance sheet carrying more cash than debt, I put the enterprise value-to-free cash flow ratio on this firm at roughly 17.0 -- a small but significant discount to growth expectations, made even more attractive by the company's modest 0.7% annual dividend payout. Bump up the growth rate, as Goldman thinks likely, and the bargain only gets bigger.