This Just In: Upgrade or Downgrade

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 track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

And speaking of the best ...
Tuesday was a good day for VMware (NYSE:VMW) shareholders. Wall Street investment house Jefferies & Co. removed its "underperform" rating on their stock, and true to form, the shares immediately began outperforming the market.

But do you want to know the best part? Jefferies is probably right.

Let's go to the tape
Oh, I know this analyst isn't usually viewed as the sharpest No. 2 in the pencil case. Over on CAPS, we have Jefferies pegged for just 48% accuracy on its recommendations over the past three years. It hasn't helped that the analyst has made some truly boneheaded recommendations in some fields:

Regardless, this banker still outperforms nearly four out of every five investors we track in CAPS. How does Jefferies do it? In large part, by being really, really good at picking software shops -- like VMware:

In fact, within the Software industry in particular, an astounding 82.6% of Jefferies' actively recommended stocks are outperforming the S&P 500. So clearly, this analyst knows a thing or two about coding.

But does Jefferies know VMware?
Once again, appearances can be deceiving here. Fact of the matter is, Jefferies has a mixed record on VMware. It recommended buying the stock back in August of '07, and got singed for 5.34 points of underperformance before turning negative back in April. (That pick has since treaded water, and it was just ended slightly up on the market.)

Regardless, I have to agree with Jefferies' improving view of the stock, based on where it's trading today. Jefferies doesn't see much downside to buying the stock now, however, arguing that early contract renewals and pre-sales of new software will help to support VMware's licensing revenues. And according to Jefferies, VMware is poised to give investors a pleasant surprise when it reports earnings next week. Last quarter's revenue should be at least as much as the Street is expecting, and perhaps a bit more.

With the stock currently trading for a little less than 18 times its trailing free cash flow, and the consensus of analyst expectations on profit growth at close to 17% over the next five years, VMware shouldn't have to do much more than meet expectations next week, and in the weeks to follow, to hold its current valuation.

So why upgrade to "hold?" Why not go ahead and buy VMware?
Jefferies only raised its price target on the stock to $25 (the stock's trading north of $29 now) -- but there's good reason for that. Jefferies believes that VMware will walk back its guidance for the current quarter when it reports on Wednesday. If correct, investors could punish the stock for short-term risks.

Hence, Jefferies is targeting a price that's currently underwater.

So what do we do now?
If it were me, I would wait. One of the best software stock-hackers in the business just told us that things are going fine at VMware -- but that there's also a significant chance that we will be able to buy the shares cheaper after the earnings report than before.

I agree. While VMware's price looks fine to me, today, there's no law against getting greedy. So, I would hold 'til the margin of safety widens.