This Just In: Upgrades and Downgrades

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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'll 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.

Easy come, easy go
A few months ago, I took issue with a decision by Morgan Stanley to upgrade shares of electric-car battery maker A123 Systems (NAS: AONE) . At the time, the analyst cited several reasons to be optimistic about the stock. For example, "several" of A123's customers were expected to "move to volume production" over the next few quarters. This promised to help fill out capacity utilization at the company, and to improve profit margins.

Best of all, Morgan was pretty sure A123 would come through on its promise to confirm the existence -- and reveal the identity -- of "a major U.S. manufacturer for an all-electric vehicle." And you know what? A123 did confirm the news, sort of, and it didfinally name names last week. On Thursday, A123 announced that it will build "thousands or up to tens of thousands of battery packs" for electric cars to be built by General Motors (NYS: GM) at some time in the "future."  

That was great news for A123 shareholders, who were treated to a one-day, 45% spike in share price. It was less good news for shareholders who bought shares on Morgan Stanley's advice, however. That 45% spike still left them with an investment worth 12% less than it was when Morgan recommended it. And the news got even worse one day later. Post-spike, Goldman Sachs announced that the shares were now definitely overvalued -- and recommended that investors cash out of A123 toute de suite.

Show me the money!
The GM news was all well and good. But Goldman worries that it did nothing to clarify "the next catalyst we think will drive the stock -- the extent of profitability longer term." In announcing the GM news, you see, A123 declined to tell investors anything about the actual size of the deal, the price of the batteries it will sell, or what profits it hopes to earn on them. "Given limited clarity on the potential range of profitability and ongoing macro uncertainty," therefore, Goldman knocked $4 off its target price for A123 and now says the stock's worth only about $5, less than it cost back when Morgan recommended it two months ago, and before the GM news!

Now, if it sounds to you like Goldman's just making up reasons to downgrade the stock -- well, it looks that way to me, too. It simply strains credulity to look at a major contract with GM and conclude that it makes A123 worth less than it was two months ago. If you ask me, Goldman is simply taking advantage of the price pop to cut its losses on A123 and exit a stock it no longer favors.

But why does Goldman no longer like A123?

Electric cars: Batteries running low
I'm just guessing here, but a few possibilities do suggest themselves. For one thing, A123's announcement doesn't really explain how GM can be using both A123's battery technology and also the battery tech it clearly preferred two years ago when it chose Korea's LG Chem over A123 as its main battery supplier.

For another, while GM's electric cars are certainly grabbing a lot of head-lines, they still don't seem to be making much headway with car buyers. As fellow Fool Rich Duprey recently pointed out, A123's new partner has had trouble selling even the "electric vehicles it has on the lot." GM "sold just 125 Chevy Volts in July and only 3,071 since the model was launched in 2010 -- hardly the groundswell of demand to support 'tens of thousands' of battery packs." The implication being that there's no guarantee the "future" car GM contracted A123 to supply will ever actually find a market.

What's more, even if it does get built, there's no guarantee GM's "future" electric cars will capture the kind of market share A123 envisions. There's still the ever-popular Prius to contend with, after all -- and now Toyota's (NYS: TM) building a plug-in hybrid version. Ford (NYS: F) is due to put out a new electric car any day now. Nissan already has one. Tesla (NAS: TSLA) has one ... and is building a better one. As if all that weren't bad enough, financial behemoth Berkshire Hathaway (NYS: BRK.B) is still backing a Chinese firm by the name of BYD, which aims to bring an e-car to market in the U.S. soon.

Foolish takeaway
That's an awful lot of caveats that investors are asking A123's 5.5 price-to-sales ratio to support. As I've pointed out before, more reliable, proven, and profitable auto-battery makers like Johnson Controls (NYS: JCI) sell for valuations just one-tenth as high as the one A123 sports. I risk understatement here, but that makes A123 look awfully expensive by comparison.

Seems to me, the real question here isn't why Goldman Sachs no longer thinks A123 is worth buying. The real question is why it ever recommended the stock in the first place.

At the time this article was published Fool contributorRich Smithdoes not own (or short) any company named above, but The Motley Fool owns shares of Berkshire Hathaway and Ford, andMotley Fool newsletter serviceshave recommended buying shares of Ford, General Motors, and Berkshire Hathaway.You can find Rich on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 468 out of more than 170,000 members.We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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