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...
If you heard what happened to Medtronic (NYSE: MDT) after it reported Q1 earnings this week, you may think that the medical equipment industry is at death's door.

The bad news: You're probably right. Fellow Fool Brian Orelli thinks Medtronic's report bodes ill for rivals Boston Scientific (NYSE: BSX) and Johnson & Johnson (NYSE: JNJ) -- and several more medical device makers as well.

And the good news? All three of the companies named above make medical devices in the U.S. But according to at least one international analyst (and a pretty good one at that), things are quite different across the Pacific. Early yesterday, Deutsche Securities took the bull side of Wall Street's bearish, anti-medical devices trade, initiating coverageof diagnostic equipment maker China Medical Technologies (Nasdaq: CMED), reinitiating coverage of Motley Fool Stock Advisor recommendation Mindray Medical (NYSE: MR), and telling investors to buy both.

The ratings
Let's look at Mindray first, since it looks like the least controversial of the two picks. According to Deutsche, Mindray's poised to deliver "sustainable growth" in both the "domestic market and emerging markets" over the next five years. The analyst posits roughly 14% annual revenue growth, alongside improving operating margins.

Curiously for a "buy" rating, however, Deutsche says "non-GAAP EPS" growth will only add up to about 14% per annum, which doesn't really tally with the projected operating-margin improvement. Even more curiously, Deutsche's buy rating assumes earnings growth more than 8 percentage points slower than the Wall Street consensus. If you're looking for a reason to own a stock priced at more than 19 times earnings, I'd think you'd really want to see something more than 14% growth out of it.

Never mind 'bout Mindray
The China Medical recommendation interests me more today. Unlike its below-consensus expectations for Mindray, Deutsche says it likes China Med largely because the stock will grow better than expected.

Whereas Wall Street's conventional wisdom says this stock is "only" a 25% grower, Deutsche thinks the diagnostics equipment maker could expand at 37% a year for five years running: "We anticipate a robust turnaround that would far exceed expectations for the following 12-18 months. As CMED's improving fundamental prospects are not reflected in the stock price, we construe substantial upside potential is likely, with limited downside risk, presenting a compelling risk reward opportunity for both value and growth investors."

That sounds pretty good to me. I have only one objection to Deutsche's recommendation to buy China Medical this week: The analyst is dead wrong.

Doctor, the patient is getting worse

  • Contrary to Deutsche's assertion of "limited downside risk" in China Medical, perils surrounding this pick abound:
  • Business risk: Deutsche tells us that China Med is "the largest ... in-vitro diagnostic company in China." But in the global business of selling medical equipment, it's dwarfed by rivals such as Beckman Coulter (NYSE: BEC) and Abbott Labs (NYSE: ABT). Both of those companies sell their goods at a profit, compared to China Med's spotty profitability.
  • Valuation risk: Given those spotty profits, it's not easy to size up China Med  based on the traditional P/E metric. However, priced in comparison to its relatively puny $103 million annual revenue stream, China Med sells for a higher price-to-sales ratio than either Abbott or Beckman.
  • Dilution risk: China Med's problems run deeper than that -- all the way down to the cash flow statement. There, we discover that China Med generated less operating cash flow last year (fiscal 2009) than in the year before, and less cash in the last three months than in the first three months of fiscal 2008 as well. While the company's not particularly forthcoming about its capital requirements, my calculations suggest it was almost certainly free cash flow-negative for all periods mentioned.

And with $376 million in debt on its balance sheet, versus less than $110 million in cash, chances are good that a failure to produce positive free cash flow soon will spur China Med to issue a new wave of stock -- diluting any shareholder who owns shares today.

Foolish takeaway
China Medical bulls will naturally argue that the stock sells for "six times forward earnings," making it a buy despite any other objections. I can't say that the hope for a single-digit P/E next year doesn't entice. I just wish there were a few more numbers of substance today to support those hopes.

Mindray Medical is a Motley Fool Rule Breakers selection. Johnson & Johnson is a Motley Fool Income Investor choice. Motley Fool Options has recommended a diagonal call position on Johnson & Johnson. The Fool owns shares of Medtronic, but Fool contributor Rich Smith does not own shares of (nor is he short) any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 498 out of more than 165,000 members. The Motley Fool has a disclosure policy.