This Just In: Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycles 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 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 ...
Shares of ethanol magnates Aventine Renewable Energy (NYSE:AVR) and VeraSun Energy (NYSE:VSE) are flying this morning, fueled by twin upgrades from one of the best stock pickers in the business: Lehman Bros. This is no surprise, considering the banker's bullish prognosis.

According to Lehman, Congress is poised to mandate an increase in the use of ethanol in fuel for cars next year. In the meantime, corn prices are stabilizing rather than skyrocketing, and the ethanol brewed from said corn is approaching the price of more mundane, benzene-based fuels. All of which, when blended in the proper proportions, leads Lehman to posit a limited "downside risk" in the ethanol makers' shares ("10 to 15 percent"), while "upside potential could be as high as 30 percent to 50 percent over the next three months."

So, 50% profits in just three months? No wonder the stocks are soaring! But is Lehman right?

Let's go to the tape
As we've observed here before, Lehman is one of the stars of CAPS, boasting a CAPS rating of 91.28 (but a less impressive accuracy record of getting 51% of its picks right). Examining its record on energy stocks in particular, we find Lehman right on the money:

And a bit less successful with:

Of the above picks, though, I think the most instructive must certainly be Lehman's record on Aventine itself, one of this morning's two upgrades. In two months' time, between April and June of this year, Lehman managed to call this one wrong to the tune of 29.5 points' underperformance versus the S&P 500.

Foolish takeaway
Despite its overall record of success, I expect Lehman to meet similar results with today's picks on Aventine and VeraSun. While I admit that the valuations look enticing from a P/E/Growth (PEG) perspective -- both firms sport attractive P/Es (of 13 and 15, respectively) relative to their projected growth rates (23% for Aventine, 22% for VeraSun) -- I see several negatives that could result in much more than Lehman's posited "10 to 15 percent ... downside risk."

For one thing, while profitable in generally accepted accounting principles, neither one currently produces any cash profits at all. On the contrary, they're both burning cash -- VeraSun furiously so, with $100 million worth of negative free cash flow over the past 12 months.

But what's more important, the U.S. has hit an inflection point in the ethanol craze -- but not the one Lehman is positing. More and more we read in the papers how farmers are overgrowing their corn crops to feed the alt-fuel frenzy. With much of the added production going straight to distilleries, this is driving up food costs across the nation (and abroad -- witness the crisis of "pricey tortillas" in Mexico), causing a below-the-radar crisis in soil erosion and similar erosion of support for ethanol in Congress.

Even if ethanol turns out to be an economical alternative to gasoline, it's widely understood that corn-based ethanol costs more to produce than our brothers in Brazil spend to manufacture ethanol from sugar cane.

In addition to all the arguments against ethanol, owning Aventine or VeraSun, instead of Brazil's Cosan, means investing in a high-cost producer in a possibly declining industry. In short, I think Lehman has had "one too many" on this call. It's time to cut this banker off, and call him a taxi.

You know what Lehman says. You know what Rich says. Looking for a third opinion on these stocks? Check out what their CAPS score leaders have to say about them:

• Aventine Renewable
• VeraSun
• And a bonus -- Cosan.

Fool contributor Rich Smith does not own shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 283 out of more than 60,000 rated players. The Fool has a corn-fed disclosure policy.