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.

Finland, meet Germany
Yesterday was a big one for telecom and consumer electronics investors. We've already discussed Needham's downgrade of Palm (NASDAQ:PALM) on concerns that the smartphone maker is selling for too rich a multiple.

But it's more than just valuation. Palm has teamed up with laggard Sprint Nextel (NYSE:S) to help palm off its wares, while rival Apple is paired with the larger AT&T (NYSE:T), and Research In Motion (NASDAQ:RIMM) has the strongest support by far -- AT&T ­and Sprint, and Verizon (NYSE:VZ) as well. Based on both the stock price and the competitive landscape Palm faces, I'm inclined to agree with Needham. Today, though, we turn to Wednesday's other big upgrade -- Deutsche Securities' endorsement of Nokia (NYSE:NOK).

On Wednesday, Deutsche argued that: "A modest macro recovery and replacement buys should underwrite handset market growth" for Nokia next year. With Wall Street estimates for 2009 earnings "bottoming," and Nokia fielding a "refreshed" handset portfolio for the perusal of would-be buyers, Deutsche believes the company stands poised to become a growth stock once more -- and encourages investors to buy today before the stock hits its target price of $19 a share.

Investors cheered yesterday's upgrade. Question is: Should they have been fleeing instead?

Let's go to the tape
Well, maybe not flee. But there is cause for worry. When it comes to picking winning stocks, Deutsche's record leaves something to be desired.

The results of more than two-and-a-half years' worth of data gathered on CAPS shows that Deutsche gets fewer than 50% of its picks right, generally. Among handset makers in particular, its record is truly terrible. See for yourself:

And here's the really bad news: As far as Nokia goes, I fear we're going to see it land on the wrong half of Deutsche's scorecard as well.

Here's why
I admit that at first glance, Nokia doesn't look like all that bad an investment. To the contrary, the company has plenty to recommend it, including:

• $3.84 billion in profit earned over the past 12 months.
• analysts predicting it will grow these profits faster than 12% per year over the next five years.
• $11.47 billion of cash in the bank, versus just $4.16 billion in long-term debt.

However, dig into the cash flow statement and you'll find that actual free cash flow backs up just 65% of Nokia's net earnings. Free cash flow over the last 12 months amounted to just $2.48 billion. As a result, what looks at first glance like a 14.5 P/E stock with 12% growth prospects turns out to be, upon closer examination, an enterprise trading for more than 20 times its annual free cash flow. Hardly a bargain.

Foolish takeaway
Look -- there's nobody who wants to see Nokia succeed more than me. I've profited greatly from investing in the company in years past. I own the stock today (purchased back when its numbers looked a darned sight better than they do today).

But facts are facts. Nokia's valuation has deteriorated significantly over the past several quarters. From where it sits now, Nokia's growth prospects simply do not add up to a compelling "buy thesis." And as for Deutsche, with its record on handset makers?

That's just the icing on an already stale cake. It adds nothing that would make Nokia seem more palatable, and to the contrary, makes the stock look even less appetizing than before.