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, too.

And speaking of the best …
Folks, let's all give a round of applause for investment banker JPMorgan Chase, which today makes its triumphant emergence from the ranks of the irredeemably bad bankers, and claws its way back into the top tiers of the nation's best financial advisors, at least according to CAPS. So let's welcome 'em back with a profile of JPMorgan's latest pick.

Sell Dell
Hmm. Gee, guys, you couldn't return to respectability on a brighter note? No matter. It's JPMorgan's "underweight" (read "sell") rating on Dell (NASDAQ:DELL) that grabbed the headlines this morning, and that's the one we'll be looking at today. Citing a probable 13.5% drop in PC shipments this year for the entire industry, with business sales taking the brunt of the damage, JPMorgan fears Dell will choose to replace lost "enterprise sales" with less profitable business, incurring higher costs. There is also the worry that Dell will run into increased competition from the likes of Lenovo, Apple (NASDAQ:AAPL), and Hewlett-Packard (NYSE:HPQ), and suffer a further slide in profit margins as a consequence.

Worst of all, JPMorgan predicts that Dell could even be at "risk of cash burn." That would be simply horrible news for a business that has historically generated piles of cash large enough to dwarf even its reported net earnings. As recently as early last year, Dell generated annual free cash flow 6% higher than net income, but over the past 12 months, the picture has already deteriorated to the point that free cash flow backs up less than 63% of net profits. Ouch.

Let's go to the tape
Rough news for Dell shareholders, no doubt. But JPMorgan just may know whereof it speaks. After months of treading water in the subterranean pools of the CAPS "Under 20"-ranked investors, JPMorgan looks "good" again, reclaiming a CAPS rating in the upper 80s. Its picks have been on a tear of late, and some recent recommendations have done particularly well:

Will this morning's downgrade add to JPMorgan's "wins" column, or drag JPMorgan back down into subpar performance?

Doomsday for Dell?
Me, I'm not entirely convinced by JPMorgan's bearish thesis on Dell -- but my skepticism differs only as a matter of degree. After reviewing the company's numbers, it's clear that Dell is moving in the wrong direction. JPMorgan correctly points out, for example, that Dell's cash conversion cycle is lengthening. Or more precisely, it's getting progressively less negative. Dell, you see, has historically run on the terrific business model of:

• Step 1: Sell the computer.
• Step 2: Get paid.
• Step 3: Build and deliver the computer.

As a result, Dell always got paid long before it ever "delivered the goods" -- a far cry from the usual retail model where you've got to borrow to buy stuff, then sell the stuff, then wait to get paid for the stuff you sold so you could pay back your loan. But the more Dell relies on sales through retail channels such as Best Buy (NYSE:BBY), the more "stuff" Dell must pay for up-front -- and the longer it must wait to get paid. If that's the row Dell continues to hoe, it's entirely possible that JPMorgan's prediction of cash burn will come to pass.

Foolish takeaway
That said ... I have to say that the stock looks cheap. Maybe even cheap enough to justify the risk. Dell's selling for a price-to-free cash flow ratio of nearly 11, and it has a huge pile of cash to insulate its valuation further. (The enterprise value-to-free cash flow ratio, for example, is just 7.0.) Relative to consensus expectations of 8.3% long-term growth, that doesn't leave us with a huge margin of safety on the stock -- but there is some.

Personally, I think the stock's still too cheap to sell it. But considering the risks inherent in JPMorgan's prognosis, I feel no compelling need to buy Dell today, either.