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 ...
With its stock up 54% over the past year, and trouncing the S&P 500's returns by a margin of 24 percentage points, is it time to take profits and sell Mindray Medical (NYSE:MR)? Far from it, says Deutsche Securities. To the contrary, now just may be the best time to buy.

Initiating coverage on the Chinese medical device baker (Dibs! We found it first!), Deutsche called Mindray "the leader in many of its product areas and a low-cost producer of medical equipment." Furthermore, says the analyst, Mindray is well-positioned "to benefit from secular trends stemming from the health care sector. The company's products in patient monitoring & life support, in-vitro diagnostics and medical imaging are considered basic equipment in a hospital setting."

But what are the chances that hospitals will ante up for big-ticket medical devices, here in the throes of the Great Recession? Let's find out.

Survey says ...
Judging from its record in the health care industry, I'd say Deutsche stands a pretty good chance of being proven right on this, its latest pick. The banker ranks near the top 10% of investors tracked by CAPS. And within the Health care Equipment and Supplies sector in particular, this stockpicker's a star. At last report, fully 10 out of 12 of Deutsche's active recommendations were outperforming the market -- some by a very wide margin. Here's a sampling:

But do the numbers add up?
Deutsche's record speaks volumes about its stock picking acumen in this space. Still, a Fool can be forgiven for wondering -- with Mindray stock selling for a premium 31 times earnings, but growth prospects possibly waning, isn't this stock too expensive to buy?

I actually believe it is too expensive -- but not for the reason you think.

Analysts today aren't exactly confident that Mindray's growth of yesteryear will maintain their blistering pace. Profits have grown 40% annually over the last five years, but the consensus up on Wall Street is that Mindray will struggle to achieve much more than half that growth rate over the next half-decade. For that matter, Mindray itself admits, in a recent SEC filing, that it only grew sales about 15% in the fourth quarter of 2009, and will likely manage just 17% revenue growth in 2010. Good numbers in and of themselves -- but a far cry from 40%.

And yet, there's a big difference between revenues and the profits that flow from them. According to its most recent earnings report, even the 17% revenue growth that Mindray experienced through the first three quarters of this year was sufficient to drive profits up 32% over last year. If Mindray can maintain this relationship between sales growth and profits growth, a 31 P/E may not look like too much to pay. In short, Deutsche may be right.

But I don't think so
Personally, I tend to focus less on GAAP numbers than on the free cash flow that undergirds them. And it's here that the Mindray buy-thesis fails to add up for me. You see, at the same time as it was reporting $102 million in year-to-date net income, Mindray also confessed that free cash flow for this year has amounted to a paltry $46.4 million. The way I look at things, therefore, the company's not trading for "a 31 P/E" -- it's trading for something more like 68-times free cash flow.

Foolish takeaway
Viewed from this perspective, it doesn't really matter to me whether Mindray grows at 17% going forward ... or at 34% ... or even its historical 40% pace of GAAP profits growth. Any way I look at it, 68-times free cash flow is too steep a price to pay for this stock.

My advice: Mind the free-cash-flow gap, folks.