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 both "best and worst" ...
One analyst from each camp closed out the trading week with an upgrade for Motley Fool Hidden Gems darling Natus Medical (NASDAQ:BABY). The company reported miserable first quarter earnings yesterday -- sales down 10%, profits plunging 70% -- but as the saying goes, every "baby" looks beautiful to its parents.

Regardless of the profits news, both William Blair and Needham adopted bullish positions on the stock. Yet I should point out that the upgrades were not entirely based on emotion. Fact is, while Natus had a bad three months at the start of 2009, its results did beat its own earnings estimate of less than a month ago, earning $0.03 per share for the quarter rather than the penny or two it had guided for. This suggests that management may have been similarly conservative with its latest guidance for the full year -- per-share profit of $0.31 to $0.34 on roughly $145 million in revenue.

But is that reason enough to recommend the stock? Or, hearing the recommendation, for investors to bid shares up 10%?

Let's go to the tape
Props first. Both of these analysts have made their fair share of winning bets in the medical sphere. Blair's report card shows such profitable picks as:

Meanwhile, Needham boasts of:

Of the two, though, Blair seems to be the more consistent winner-picker, showing 51% accuracy in its recommendations, versus a lowly 44% for Needham. Its record for accuracy is a primary reason why Blair ranks in the top quintile of investors tracked by CAPS, while Needham slides down to the bottom 40%.

How much bounce has BABY got?
Sadly, with one good analyst and one bad, both saying the same thing today: "Buy, BABY, buy," I'm afraid the upgrades cancel themselves out. And the tiebreaker on this stock, therefore, is its own valuation.

As a Natus shareholder myself, I'd love to be able to tell you that there's so much margin of safety in this stock's price that you can afford to ignore the analysts and just buy it on its own merits -- but I can't, for two reasons:

First, we're lacking some important information on Natus today. While the company reported earnings Thursday, it left out a lot of the most important data an investor requires to make an informed investment decision. The balance sheet, for one thing. The cash flow statement, for another. And seeing as it took Natus until just last month to release its 10-K filing for last year, I'm afraid investors may be in for a long wait before we get to see these crucial documents.

Until then, all we've got to work with here are reported GAAP net income through Q1 2009, and free cash flow as of the close of last year. The former shows the firm selling for a 17.8 P/E right now, against 20% predicted long-term growth -- not bad at all. Problem is, the latter shows Natus generating a mere $8.2 million in free cash flow last year -- and with the first quarter of this year looking mighty ugly, I suspect we'll eventually learn there was a decline in free cash flow.

Foolish takeaway
Natus's price-to-free cash flow ratio of 34.4 (currently) was smelling pretty ripe even before we unwrapped the diaper containing Q1 results. I very much fear that when the complete data on Q1 comes out, we'll find the valuation even stinkier. My advice: Keep a safe distance.