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 the best ...
Owners of Corning (NYSE:GLW) stock enjoyed a banner day on Wall Street this morning, as their ticker flashes green, and leads the market upwards. What's the buzz? Turns out, Oppenheimer has upgraded the shares to "outperform," and predicted the shares will see $19.

Lamenting the fact that Corning has been "flat-lined" for the past few months, Oppenheimer suggests that investors are being too pessimistic about the company's prospects. Says Oppenheimer: 

• "Street estimates are ... achievable"
• "Muted" international growth should suffice to help Corning earn $1.50 next year.
• Even after "LCD inventory replenishment runs its course," this company will continue to do well.

None of which I disagree with -- but I still don't think Corning is a "buy."

Let's go to the tape
Now, before I go poking holes in Oppenheimer's argument, let's give this analyst its due. Generally speaking, Oppy is more often right than wrong on its picks. The analyst scores 51% for accuracy on its recommendations over the past three years, and ranks in the 86th percentile of investors tracked by CAPS -- thanks in large part to picks like these:

In contrast, Oppenheimer's mistakes within the Communications Equipment sector have been rarer, and less significant in size:

Last but not least, Oppenheimer's record within this particular sector exceeds its overall record across the breadth of the stock market -- when picking tech stocks like Corning, Harris enjoys nearly a 55% success rate (which is harder than it looks.)

So what's the problem?
So here we have an above average analyst ... with a particularly above average record in the Communication Equipment space ... making a perfectly reasonable argument for how much Corning can earn next year ... which argument, if proven correct, would have the stock trading for an acceptable 11 times forward earnings. What could possibly be wrong with that?

Nothing at all, save for the picky little detail that it misses the point entirely.

Yes, Corning earns a lot of money, as GAAP calculates such things. Problem is, from a free-cash-flow perspective, it hardly earns anything at all. Most of the "profit" that Corning brings in one door as operating cash flow quickly exits out another door as capital expenditures.

Now, as the CEO readily admits: "As a technology innovation company that focuses on materials conversion, Corning is a capital-intensive company." GAAP lets Corning depreciate its capital investments over time, inflating earnings in the short term as they're expensed over many years. And that would be fine if, eventually, Corning got to a point where it could stop pouring money into capital improvements, and just use the equipment it's got to manufacture and sell LCD glass, fiber optic cable, and so on -- yielding free cash on the investment.

I'm tired of Corning making me wait
But it can't. Over the five years that I've been watching this company, I've waited in vain to see a real trend of capital expenditures declining and free cash flow swelling to a roar. Instead, Corning seems to be perpetually running in place. Even as it reported "earning" in excess of $2 billion a year on average, its actual free cash flow has amounted to barely $450 million per annum. In fact, honest-to-goodness free cash backed up less than 14% of Corning's reported earnings for the past 12 months.

Foolish takeaway
There's nothing wrong with being a tech leader, and investing heavily on capital equipment -- so long as that investment eventually pays off in the form of simply obscene amounts of unencumbered free cash flow for your shareholders. Some companies succeed at this -- Apple for one; Cisco for another.

But Corning isn't the third.