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

And speaking of the best ...
Shareholders of Motley Fool Rule Breakers recommendation Mindray Medical (NYSE:MR) received words of encouragement -- and a 2% bump in stock price -- when All-Star analyst Soleil Securities initiated coverage with a "buy" recommendation yesterday. Why does Soleil think Mindray's bright 'n' shiny? For several reasons:

From the macro perspective, Soleil notes that China is in the midst of a major health-care reform spurt. Through 2011, the country will spend some $123 billion on the effort. And as the No. 1 or No. 2 player in most of its markets, Mindray should get a big slice of the spending pie. Mindray's big in other respects, too. Soleil particularly likes the company's network of more than 2,000 distributors in China, roughly 60% of which distribute Mindray products exclusively.

Good as all this sounds, it's not the only factor in Mindray's favor. The company actually makes more sales internationally than it does within the Middle Kingdom. And with Mindray's medical equipment often underpricing the competition by 25% to 30%, the company should be able to gain share abroad -- the more so, inasmuch as Mindray continues to churn out innovative products. New-to-market products made up fully 25% of the company's 2008 sales.

And yet, Mindray shares look undeniably pricey at 31 times earnings. Grand as the Mindray story sounds, isn't Soleil's enthusiasm a bit overheated?

Let's go to the tape
For clues to this analyst's stock-picking prowess, we turn once again to Motley Fool CAPS and take a look at its record in the medical sphere. What we find there is ... well, the prognosis is grim.

Soleil may have a decent grip on stocks in general -- it does, after all, rank in the top 20% of investors tracked on CAPS. It made a great call endorsing Ford (NYSE:F) last year, and its long-standing recommendation of IBM (NYSE:IBM) has been thrashing the market's returns for three years straight. But Soleil's record on health-care stocks would make a malpractice insurer cringe:

Soleil is three-for-three on recommendations in the Life Sciences Tools and Services sector over the past few years, but the majority of its recommendations in the fields of Pharmaceuticals and Healthcare Equipment and Supplies (Mindray's home turf) go awry. I very much fear that's the fate that awaits this week's recommendation of Mindray.

Why? Let me start by saying that I agree 100% with Soleil that Mindray is a quality outfit, and doubt 100% that it would have made the cut for our Motley Fool Rule Breakers portfolio if that weren't the case. But the problem with Mindray is two-fold:

First, 31 times earnings is an awful lot to pay for a stock in the overheated Chinese market. Analysts may believe that Mindray will grow its profit at close to 29% per year over the next five years, but to my mind, even if Wall Street's right about the growth rate, it makes the stock only "fairly valued." If they're mistaken -- even by a little -- this stock could fall far and fast.

And I think they are wrong. To me, the quality of Mindray's earnings looks suspect, given that in each of the last two fiscal years this company's reported earnings under generally accepted accounting principles (GAAP) vastly outpaced its actual free cash flow.

Second, the company acquired a patient-monitoring-device business last year for $209 million, and financed the deal with a short-term loan, a part of which Mindray had to roll over into longer-term debt this year. That leaves the company with $66 million in long-term debt and $109 million in short-term borrowings. That's a change from a perfectly clean balance sheet -- one that Mindray would likely still have if it were generating free cash at the same rate it was reporting net income. While that debt won't be enough to capsize the company (not with $120 million in cash and more on the way), it does suggest to me a troubling trend.

Foolish takeaway
Mindray Medical looks to me like the proverbial "great company, lousy stock." While I love the business, I simply don't see a lot of upside to the stock at this valuation. My advice: Take two aspirin and call me when Mindray's cheaper.

What's your diagnosis? Hop over to Mindray's page in CAPS and let the community know.