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This Just In: Upgrades and Downgrades

By Rich Smith - Apr 3, 2013 at 5:00PM

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UBS offers up one buy and one sell.

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.

One stock to buy, and one to sell
Today we've got an Internet-stocks ratings two-fer to offer you: A buy rating for AOL (NYSE: AOL), and a sell for Groupon (GRPN -3.59%). Both ratings come courtesy of Swiss megabanker UBS. Is UBS right about these?

Let's go to the tape
Initial indications look good. Ranked in the top 10% of investors we track here at CAPS, UBS boasts a record of 51% accuracy on its picks. Judging from the historical record, a stock UBS tells you to buy (AOL, in this case) will generally outperform the market by about eight percentage points. Conversely, a stock UBS warns you to dump (this week, that's Groupon) will proceed to underperform the market by about eight points over time -- and the news gets better.

UBS has proven itself a particularly astute picker of "Internet" stocks. Since we began tracking this analyst's performance back in 2006, UBS's recommendations in the Internet software and services sphere have tended to outperform the market an impressive 59% of the time. This analyst's been particularly successful on both the upside and the downside with recommendations such as...

Stock 

UBS Said:

CAPS Says:

UBS' Picks Beating S&P By:

eBay

Outperform

****

81 points

Google

Outperform

****

57 points

Dice Holdings

Underperform

**

55 points

But is UBS right this time?
A record this good lends a lot of confidence that UBS knows what it's talking about when it says today that you should buy AOL and sell Groupon. But that's not the only reason I agree with the analyst -- on both counts.

AOL
In its write-up on AOL, UBS predicts that after years of stagnation, the Internet portal and media magnate is set to grow its revenue for the first time in eight years. The analyst also likes AOL's history of "shareholder-friendly capital returns and an improving margin profile."

And indeed, most investors seem to agree. On average, analysts have AOL pegged for 27% annualized earnings growth over the next five years -- a number that looks very attractive when compared to its 3.4 trailing P/E ratio, its 10 times valuation relative to free cash flow, or even its 22 forward P/E.

Personally, I like the odds on AOL's outperforming the market. Fact is, even if UBS wasn't recommending the stock, I probably would.

Groupon
But Groupon? Not so much. On the one hand, here we've got a stock boasting strong free cash flow today, but one where FCF is also deteriorating fast. Operating cash flow at Groupon slipped 8% last year, while capital spending more than doubled.

At a valuation today of nearly 22 times FCF, therefore, even analyst promises of near-22% earnings growth at Groupon don't entice me to buy the stock -- because despite all the happy talk coming out of analysts who aren't UBS, the facts suggest that Groupon's business is on a downward slope. Meanwhile, UBS' warning of "significant" profit margin compression at Groupon in the near future doesn't encourage confidence in the other guys' growth story, either.

Foolish takeaway
Praised by UBS, AOL is a cheap stock that looks cheap enough to buy. Panned by the banker, Groupon looks like a sell to me. And whatever you think of my take on the stocks' valuations, UBS clearly has the track record to back up its advice to buy the one, and sell the other.

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Stocks Mentioned

Groupon, Inc. Stock Quote
Groupon, Inc.
GRPN
$12.07 (-3.59%) $0.45
Alphabet Inc. Stock Quote
Alphabet Inc.
GOOGL
$2,178.16 (-1.34%) $-29.52
eBay Inc. Stock Quote
eBay Inc.
EBAY
$44.31 (-0.69%) $0.31
DHI Group, Inc. Stock Quote
DHI Group, Inc.
DHX
$6.53 (-1.51%) $0.10

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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