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.

And speaking of the worst ...
As trading drew to a close on Friday, one Wall Street wizard fired off a parting shot at longtime Motley Fool Hidden Gems recommendation Portfolio Recovery Associates (NASDAQ:PRAA). Downgraded to "underperform," the stock promptly closed down 5%.

We know who the analyst was: Jefferies & Co. What we don't know is why Jefferies hates Portfolio Recovery. At least two independent sources have confirmed that the downgrade happened, but not a single major media outlet has reported why it happened.

Let's go to the tape
As an individual investor, I know how frustrating this can be -- seeing a sell rating slapped on your stock, with no one bothering to tell you why. But when something like this happens, there is at least one place an investor can turn for guidance and perspective: Motley Fool CAPS. We may not know exactly what Jefferies was thinking last week. But thanks to CAPS, we can at least tell you how well it thinks.

Not so well, it turns out. After tracking Jefferies' performance for more than two years now (650 picks), we can say with some authority that this analyst is not the brightest bulb on the chandelier. Three times out of five, when Jefferies tells you a stock will outperform the market -- it underperforms instead (and vice versa).

Here are some of Jefferies' picks that turned out well:

However, as a general rule, your average Jefferies pick has a pronounced tendency to move in the opposite direction from what the analyst predicts, and to underperform the S&P 500 by as much as five percentage points -- or worse:

So does Portfolio Recovery belong in your portfolio? Jefferies doesn't seem to think so, but it's been wrong before (and often). And the numbers I'm looking at tell me Jefferies is wrong again. Fact is, I don't know many stocks more deserving of a buy rating than Portfolio Recovery.

Buy the numbers
Consider: From a plain vanilla price-to-earnings ratio perspective, Portfolio Recovery looks somewhere between fairly priced and moderately undervalued. The stock carries a low 11 P/E, while the analysts tracking it by and large expect 14% long-term earnings growth.

Now, almost any value investor will tell you that a stock with a 0.8 PEG ratio is probably a buy -- but this story is even better than it looks on the surface. You see, P/E is based on reported earnings as calculated under GAAP. But in fact, Portfolio Recovery makes a whole lot more money than shows up on its GAAP income statement. "Accounting profits" amounted to $45.4 million over the past 12 months, but the company's cash flow statement shows that Portfolio Recovery actually generated more than $79 million in free cash flow over that period -- fully 74% better than GAAP would have you believe.

Foolish takeaway
On the surface, Portfolio Recovery looks eminently buyable. And seeing as its free cash flow outweighs its accounting profits by nearly twice, I'm even tempted to call the stock "dirt cheap." Agree or disagree, any way you slice it, one thing is clear: Jefferies is clearly mistaken in calling this stock a "sell."

Once investors realize their mistake in selling it on Jefferies' say-so, Portfolio is bound for recovery.