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." Today, we're going to try and show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

Banker on a hill
Investing in banks hasn't been an enterprise for the meek of heart these past few years. But for those few who kept the faith in Zions Bancorp (Nasdaq: ZION), the pilgrimage has proved profitable. Yesterday, the regional banker announced Q1 earnings that quite simply stunned the Street. Zions improved its ratio of nonperforming loans, and as anticipated losses declined, it began freeing up reserves against said losses, boosting its profits from an expected $0.18-per-share loss to an $0.08-per-share gain.

As a result, Wells Fargo, FBR, Jefferies, and Raymond James all improved their opinions of Zions yesterday. Most analysts upgraded the stock to various flavors of "buy," while even Jefferies, which maintained its "hold" rating, upped its earnings estimates and increased its price target on the stock to $26. But is Wall Street's newfound religion regarding Zions really warranted? And should investors join in the revival?

Let's go to the tape
Perhaps not. After all, surveying the records of the raters, it appears that neither Wells Fargo nor Raymond James possesses much of a track record in banking, according to CAPS -- or at least, none that it's willing to share with the ratings aggregators at Briefing.com. Alas, that's the good news. If we focus on the analysts that do have extensive published records in banking, the results aren't encouraging.

FBR spends a huge amount of time opining on banking, its third-most covered industry, with 73 affirmative buy/sell ratings recorded over the past five years. It gushed yesterday about how Zions's "credit trends are obviously getting better than we originally expected" and predicted "reserve releases running closer to $100M–$125M per quarter through FY11."

Unfortunately, FBR has underperformed the market on the majority of its recommendations in commercial banking, goofed on most of its thrift picks as well, and gotten four out of five bets in the diversified financial services sector wrong, including:

What's more, among the four analysts that chimed in on Zions yesterday, the one that's arguably the least optimistic has the best record on banks. According to our CAPS stats, Jefferies has historically gotten 60% of its bets right in the commercial banking industry, and beat the market on an astounding 71% of its consumer-finance recommendations.

Yet even as Jefferies admits that it sees "better credit quality and strong capital ratios" at Zions, and agrees this will "help the case for TARP repayment," the analyst warns that the timing of that repayment remains unclear. Furthermore, the analyst notes that when Zions does begin repaying its government loans, investors should expect at least $600 million worth of stock dilution, as Zions floats "a common issuance" to raise the cash needed to give the government its due. This suggests that full repayment of TARP will require Zions to float a cool $1.5 billion worth of new shares, diluting existing shareholders by nearly 25%. Bear that in mind when deciding whether to follow the other analysts' advice to buy Zions today, pre-dilution ...

Foolish final thought
One final concern before we close out today's column. Zions isn't the only banker reporting earnings this week, and as the reports come out, we're starting to get a picture of bigger trends in the industry. According to The Wall Street Journal, reports show that a broad freeing-up of loss reserves has helped boost profits at US Bancorp, Regions Financial (NYSE: RF), and Comerica (NYSE: CMA) as well. But the news isn't all good: "While loan books grew, lackluster demand for loans continues to reflect an uncertain economy and clouds the banking industry's revenue outlook."

USB in particular is lamenting that loan growth to date has been "wholly insufficient ... given the money we have to deploy back into loans." M&T Bank (NYSE: MTB) seconded the emotion, while KeyCorp (NYSE: KEY) said that even though it is seeing good loan growth, bad real estate loans are continuing to weigh on its results.

In short, we're not entirely out of the woods yet. With Zions Bancorp still unprofitable on a trailing basis, and selling for 14 times forward earnings (against long-term earnings growth that's still estimated at barely 8% per year), now may be a great time to capitalize on the sudden crowding of analysts around the stock -- and exit stage left.