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 this, 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.

Buy 'em all
Citigroup, JPMorgan, Wells Fargo -- an investor looking for tech advice on his investments has any number of big, well-known, brand-name banks to choose from. ISI Group isn't one of them.

ISI is nonetheless the subject of today's column. Why? Because on Friday, this less famous New York-based broker-dealer made headlines with a raft of new recommendations on Wall Street. Initiating coverage on nearly a dozen of the biggest names in tech, ISI found several stocks it likes (and only a few it doesn't). The names it picked, however, may surprise you -- because from a surface-level vantage point, almost none of them are obvious bargains. Let's take a look:

Source: finviz.com.

Now on the surface, as I said, these recommendations from ISI seem curious. After all, if you're a traditional "value" investor, you'll no doubt notice that only two of these companies -- Apple and HP -- sport PEG ratios of less than 1.0. (Put another way, only these two companies have P/E ratios lower than their anticipated growth rates.) This raises the question: Is ISI Group right? Could these apparently overpriced stocks actually be bargains at today's prices?

Beauty is skin deep. Value goes deeper
As a matter of fact, yes. I think ISI is right about the majority of its recommendations, and I'll tell you why. First off, while only two out of the 11 stocks named above sport particularly pretty PEGs, nearly every one of them is generating real cash profits far in excess of the GAAP earnings that go into making up a PEG ratio. Free cash flow at EMC, F5, and NetApp is at least 50% higher than reported net income. VMware spins off cash at more than twice the rate it reports the stuff as earnings, and Brocade is nearly three times more profitable on an FCF basis, as its income statement suggests.

In short, all of the stocks ISI is recommending look like bargains to me. (Yes, even HP, with its subpar growth rate, is cheap relative to both free cash flow and net income.) In contrast, the three stocks ISI is less sure of -- IBM, Brocade, and Dell -- range from modestly overvalued, to only fairly valued.

Proof, meet pudding
These results, once you dig deep into the free cash flow, may surprise you -- especially coming from a relative unknown like ISI Group. But they don't surprise me, and I'll wager they don't surprise many investors who follow our rankings on Motley Fool CAPS.

Since we began tracking ISI's progress on CAPS, it's become apparent that this analyst has real skill in picking tech stocks. Prior to Friday, it had only made nine such recommendations -- but it got seven of them right. Suffice it to say, I don't think ISI racked up a 78% record for accuracy on its past picks by accident. And considering the quality of its latest round of draft picks, I think investors who follow ISI's advice today will be proven right as well. 

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