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.
And speaking of the best...
Early today the Dow was down 0.8%, while shares of Texas Instruments (NYSE: TXN) had lost just 0.6% of their market cap. To me, that seems curious. I mean, you might expect that on a down-market day like today, TI would be suffering even worse than it is. After all, unlike most stocks on the market, TI got itself downgraded today -- and by one of the best analysts in the business...
This morning, you see, top-5%-rated investment banker Sterne Agee announced that after gaining 18% in value over the past 52 weeks, and "beating earnings" last week, TI's run is done. Mr. Market has already been worrying about the effects that Nokia's (NYSE: NOK) weakness will have on TI. But according to Sterne, the situation's even worse than just one customer's weakness might suggest: "We believe industrial markets are starting to weaken in the U.S. and China, which could dampen the seasonal (second-half) upside." With TI inventories already up "modestly" from Q1, any slack in demand could force TI to cut prices to move inventory -- hurting both profit margins and earnings at the company.
So far, TI's strength relative to the rest of the market suggests investors are taking the news in stride. But I'm not sure they should be so complacent -- about TI, or its peers.
TI: Buy the numbers
I mean, yes, on the surface TI stock doesn't look particularly risky. The company sports a modest 11 times earnings P/E ratio. It's pegged by the average analyst for 11% long-term growth, and pays a 1.7% dividend. On the surface, the stock actually looks modestly undervalued. To see the risks here, though, you need to dig deeper.
For example, on TI's cash flow statement, we see that at the same time as TI was reporting $3.1 billion in trailing-12-month accounting earnings, the company generated only $2.5 billion in free cash flow. That's a 20% discrepancy there, folks. It means that a company that most investors think of as being an "11 P/E stock" should more accurately be viewed as a firm selling for 13.4 times the amount of cash it generates in a year.
And at the same time as we call its "P" into question, Sterne is telling us the rate of growth in TI's "E" might also be unrealistic. If demand slumps in China and the U.S., TI might very well grow less quickly than 11% per year. How overpriced might the stock appear, I wonder, if all TI manages to produce is 10% annual growth? 9%? 8%?
The next shoe to drop
I suspect it's similar worries that caused Sterne to downgrade two of TI's peers today. At the same time as it dropped TI to neutral, Sterne similarly ratcheted back expectations for Diodes Incorporated (Nasdaq: DIOD) and Analog Devices (NYSE: ADI), two semi shops with P/E ratios similar to TI's. And it's entirely possible the damage won't stop here.
Right now, Sterne Agee maintains buy recommendations for three more of TI's peers, CEVA (Nasdaq: CEVA), AMD (NYSE: AMD), and Intel (Nasdaq: INTC). Of the three, AMD and Intel both sport growth projections in line with TI, but significantly lower P/E ratios. I suspect this lower valuation may preserve them from downgrade menace. CEVA, however, trades for a lofty 39 times earnings, a valuation heavily dependent on expectations that it can maintain a sprightly 21% rate of annual growth. Of the three, I suspect it's particularly susceptible to downgrade risk.
Foolish takeaway
Texas Instruments may be the first semiconductor stock to get the axe at Sterne Agee. It may be the one with the highest profile -- but it won't be the last. If you're invested in semis today, it's time to start considering whether you want to keep investing in them tomorrow.
