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...
Two months ago, I took a hammer to Goldman Sachs and its ill-considered decision to recommend buying shares of speech-to-text specialist Nuance Communications (Nasdaq: NUAN). One month ago, I revisited the company (and the analyst), and blasted Goldman yet again when it downgraded the shares in the wake of a disastrous Q3 earnings report. Now, at the tail-end of September, another analyst has recommended that investors buy Nuance.

Yet again, this analyst is wrong.

Third verse, same as the first
UBS may be different from Goldman, but its message is eerily similar. If Nuance grows at the 12.4% annual rate it's achieved over the last three years, UBS tells us that that company is cheap at 11.7 times forward earnings.

That sounds logical on its face, but does this bull thesis stand up any better to close examination than the one Goldman gave us back in July?

Let's go to the tape
Judging from the most reliable metric I know -- historical performance on similar recommendations -- there's every reason to believe that UBS is right to recommend Nuance today. One of the best stockpickers I know, UBS ranks in the top 10% of investors we track on CAPS. Its record picking Software stocks in particular has been simply stellar: 

Companies

UBS Says

CAPS Says

UBS's Picks Beating (Lagging) S&P by

salesforce.com (NYSE: CRM)

Outperform

*

140 points (3 picks)

Oracle (Nasdaq: ORCL)

Outperform

****

60 points

Adobe Systems (Nasdaq: ADBE)

Outperform

***

(2 points) (4 picks)

UBS is literally right twice as often as it's wrong on its picks in this sector, with its average Software recommendation outperforming the market by a good 12 percentage points. Since two separate Fool publications -- Motley Fool Stock Advisor and Motley Fool Hidden Gems -- have also recommended buying Nuance, I suppose I should be cheering UBS's endorsement today. But I'm not -- at least, not entirely.

Buy these numbers?
UBS says that the company's 11.7-times-next-year's-profits price, and its "3.7x EV/sales" valuation, make Nuance "a more digestible price for a potential acquirer." Interestingly, this jibes somewhat with what Goldman Sachs was saying back in July, differing only in emphasis.

Back then, Goldman compared Nuance to software peers such as Salesforce, Oracle and Adobe, along with Microsoft (Nasdaq: MSFT), VMware (Nasdaq: VMW), and Akamai (Nasdaq: AKAM). Running the numbers, I found Nuance selling for an approximately equal valuation relative to some of these companies, but carrying a much lower P/E than others:

  • Akamai, now selling for 32 times next year's earnings.
  • VMware, with its 52 forward P/E,.
  • Salesforce, clipping the clouds at 78 times forward earnings.

Goldman viewed these high valuations on other software stocks as evidence that Nuance deserved a higher P/E ratio as well. But if viewed from UBS's angle, it also suggests that Nuance might indeed look cheap to these potential acquirers. In an all-stock purchase, they should be able to deploy their richly valued stock as an inflated currency to acquire Nuance on the cheap.

Foolish final thought
If that's the way things play out -- if Nuance is offered, and decides to accept an all-stock buyout -- then it's entirely possible that UBS will be proven right once again on today's recommendation. But personally, I still see risk in investing on hopes of a buyout.

Remember -- we're still talking here about a company that has not reported an annual GAAP profit in nearly a decade. While it generates copious cash, Nuance still sells for more than 19 times free cash flow. Yet as UBS informs us, it has averaged only about 12% growth on average over the last three years. To me, that seems a pretty rich price for acquirer to pay. It's not a price I want to pay.

Nuance shareholders can hope that UBS is right, and that any bidders who do emerge from the woodwork are a bit freer with their coin than I am.

Nuance is a Motley Fool Hidden Gems selection. Microsoft is an Inside Value choice. Akamai Technologies, Salesforce.com, and VMware are Rule Breakers recommendations. Adobe and Nuance are Stock Advisor picks. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Microsoft and Oracle.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

Fool contributor Rich Smith has no position in any of the stocks named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 548 out of more than 165,000 members. The Motley Fool has a disclosure policy.