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." So you might think we'd be the last people to give virtual ink to such "news." And we would be -- if that were all we were doing.

But in "This Just In," we don't simply tell you what the analysts said. We'll 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'll be tracking the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

And speaking of the best ...
Shares of Chinese ringtone and cell phone game-purveyor KongZhong (NASDAQ:KONG) tumbled Friday morning in the wake of a downgrade to "negative" from Pennsylvanian stock picker Susquehanna International. Unfortunately, that's not just the beginning of this story, but the end of it, too. News reports keep entirely mum on Susquehanna's reason for the downgrade. Even so, "everywhere that [Susquehanna] went, the [investors seem] sure to go." Baa-aa!

But is Susquehanna really as reliable a leader as the venerable Mary of nursery rhyme lore? Should investors be blindly following this analyst's lead in selling of KongZhong? Answering that question isn't as easy as it might appear at first glance.

Let's go to the tape
At first glance, you see, Susquehanna looks like one of the worst stock pickers on the planet. The firm gets three out of every five stock calls wrong, and scores a sub-40 CAPS rating, suggesting that more than six out of ten investors -- many of whom do not own their own investment banks -- are better off investing on their own than listening to Susquehanna.

Over the year we've been tracking its performance, Susquehanna has produced the following disappointments:

Depressing, huh? But wait -- this story gets curiouser ...

What that tells me is that while overall, Susquehanna is a pretty average stock picker, when it comes to China, this broker knows its stuff. That single pick of Baidu balanced out a lot of mistakes in the Western hemisphere.

... and curiouser
Further confusing matters, though, is Susquehanna's record on KongZhong in particular. Reviewing Susquehanna's history of upgrades and downgrades on the stock, as recorded by CAPS' data provider, Briefing.com, we see that Susquehanna initially missed an 8% rise in price on KongZhong when it initiated coverage at "neutral" in January 2006. The analyst's switch to "positive" sentiment in April 2006 proved ill-timed, as the stock proceeded to lose 40% of its value through November, when Susquehanna returned to "neutral" on the stock -- which has remained flat since.

So to sum up, what we're looking at here is:

• a generally average analyst house ...
• that's really good on China in particular ...
• but really lousy on KongZhong, in particular-er ...
• downgrading said KongZhong, and telling no one why.

Crunching all of that data, I wind up with a serious case of logical lockjaw. To break the impasse, I'm going to return to my analysis of KongZhong as laid out in my column "Wall Street's Buy List," which appeared earlier this week. There, I argued that with a trailing enterprise value-to-free cash flow ratio in the mid-single digits, and growth projected by most analysts to average 18% per year over the next five years, KongZhong looked "cheap."

Until Susquehanna produces some logical argument suggesting that the promised growth won't appear, I'm sticking with my opinion.