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 worst ...
Tuesday was a good day to be an investor, and it was a really good day to be invested in retail. It seems like everybody who was anybody "went up" yesterday. In particular, the nation's specialty retailers prospered as Wall Street wizard Jefferies & Co. handed out "buy" ratings like a too-eager Easter Bunny, jacked up on Red Bull and just back from a bulk sale on eggs and Paas dye. Jefferies' advice on ...

• United Stationers? Buy.
• Target (NYSE:TGT)? Buy.
• Lowe's (NYSE:LOW) and Kohl's (NYSE:KSS)? Costco (NASDAQ:COST) and Home Depot (NYSE:HD)? Say it with me, in a Cramer-like staccato: "Buy, buy, buy, buy!"
• And needless to say: Best Buy (NYSE:BBY). Duh. It's right there in the name! Buy.

According to Jefferies, you should buy Home Depot's cost-cutting efforts, and buy Lowe's because it's smaller and faster-growing than is Home Depot. Costco gets the nod for making market share gains (on the back of strangled profit margins), while Jefferies applauds Kohl's efforts to keep tight rein on its inventories. Though the reasons vary from store to store, it seems like there's almost no one in retail that Jefferies doesn't like right now.

But should you follow this analyst's lead?

Um, no.
Here's the problem in a nutshell, Fools: Jefferies just isn't that great as an analyst, at least according to CAPS. Two years of tracking its performance on CAPS have shown us that Jefferies gets only about 45% of its picks correct, with its average recommendation underperforming the S&P 500 by nearly two percentage points. And while it's true that Jefferies has made the right call from time to time (its February 2009 recommendation to buy Whole Foods (NASDAQ:WFMI), for example, is currently crushing the market's returns), overall, this analyst's record is abysmal.

Buy -- no, sell -- the numbers
Even if Jefferies' record looked better than it does, however, I'd be leery of investing in these stocks based solely on the numbers. To show you what I mean, let's look at a few statistics on Jefferies' fab-seven:

*Based on most recent cash flow data filed with the SEC. EV/FCF = enterprise value / free cash flow. Data provided by Capital IQ.

Do you see what I see?
I have to tell you folks: Whatever it is that Jefferies sees in these stocks, I do not see it. At least not in the table above.

Sure, from a plain vanilla price-to-earnings perspective, Best Buy, Lowe's, and Target appear cheap, and it seems that United Stationers should be anything but, well, stationary. But that's only part of the story. Examine these retailers' actual free cash flow in relation to their enterprise value, and not a one of them looks anywhere near a decent valuation right now (although Home Depot comes close).

But the situation is actually even worse than that. Because as we stand here, hip-deep in recession already, and wading further in with every passing day, several of these firms are toting hefty debt loads into the muck -- Lowe's, Home Depot, and especially Target and United Stationers.

Foolish takeaway
Call me a Fool if you like, but I just don't see the sense in betting on a bunch of overpriced, underselling retailers, burdened by debt, to restore my fortunes as the economy recovers -- not when the market is chock-full of out-and-out bargains. Furthermore, I'm not at all convinced we are on the cusp of a recovery. Fellow Fool Alyce Lomax recently made a strong case that the economy is about to take a major turn for the worse.

But if you're an ultra-patient investor, and know that a recovery will eventually arrive, and want to place your bet on just one of Jefferies' picks today, which one should you choose? If you twist my arm and force me to toss a dart, I'd suggest that of the seven, Home Depot is probably your best bet. The valuation's not extreme (though it's hardly cheap) on that one. Plus, it pays the biggest dividend yield of the bunch. In a sideways-to-down market like this one, there's something to be said for a steady 4.2%.