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.

Pronouncing death on medical equipment stocks
When Medtronic (NYS: MDT) reported earnings Tuesday, it left a lot of investors smiling. A lot, but not all. Shareholders of two other medical equipment stocks have reason to be frowning in resentment; Morgan Keegan probably wouldn't have downgraded shares of Boston Scientific (NYS: BSX) and Abbott Labs (NYS: ABT) if Medtronic hadn't given its blunt assessment of its own weak sales prospects in medical equipment.

Yesterday, Morgan Keegan cited Medtronic's forecast of 1% to 3% revenue growth as proof that hospitals are cutting spending on medical equipment. Meanwhile, "continued weakness in and uncertainty about the U.S. economy" and "continued eurozone challenges" threaten to depress sales throughout the industry. Result: The analyst, which had previously endorsed buying shares of both Boston Scientific and Abbott, now considers both companies only "market performers," and it lowered its price targets on the stocks, as well.

Let's go to the tape
Should that worry you? Is Morgan Keegan a good enough stock picker that when it loses faith in a company, investors should follow suit -- and sell? I've got good news and bad news.

Good news first: If you own shares of Abbott Labs, then no -- you absolutely should not follow Morgan Keegan's advice today. Bad news -- if you own Boston Scientific, you probably want to rethink that investment. More on that in a moment.

Abbott Labs: Buy the numbers
Let's take Abbott first. According to Morgan Keegan, Medtronic's forecast, combined with the still-weak economy, have vaporized all "relative upside" at Abbott. But according to the numbers I'm looking at, Morgan Keegan's assessment couldn't be further from the truth.

Sure, relative to the competition, Abbott shares don't look crazy-cheap today. At 15.3 times earnings, Abbott sells for only a small discount to the earnings multiples at Johnson & Johnson (NYS: JNJ) and Boston Scientific, and it costs a whole lot more than Medtronic with its P/E of 12. If Abbott seems cheaper than more cutting-edge medical equipment tech stocks like Intuitive Surgical (NAS: ISRG) and MELA Sciences (NAS: MELA) , well, it's not growing at anywhere near those companies' growth rates, either.

In fact, the 9% long-term growth rate that analysts project for Abbott is more than enough to make the stock a bargain today. Why? Because the GAAP earnings at Abbott don't come close to reflecting the true cash-generating power of this company. Over the past 12 months, Abbott reported earning $5.1 billion in earnings, but it generated $8.1 billion in free cash flow. In other words, this supposed "15 P/E stock" actually costs less than 10 times the amount of cash profit it earns in a year, and Abbott sweetens the deal even more with a generous 3.8% dividend. To my Foolish eye, this makes Abbott a buy.

Boston Scientific: And what about these numbers?
In contrast, I don't see nearly as much value in Boston Scientific today. If Morgan Keegan is downgrading this one, I think its main mistake is in not going far down enough, rating the stock only a "hold." Unlike Abbott, which generates significantly more free cash than it reports as net income, and pays a monster dividend, Boston Scientific ... doesn't.

It generates less free cash ($323 million versus GAAP "income" of $618 million) and it pays no dividend whatsoever. It's a worse deal than Abbott in every way, and deserving of a much lower rating.

Foolish final thought
So why doesn't Morgan Keegan give Boston Scientific the lower rating? Why does it rate Abbott less valuable than the company clearly is?

Not to put too fine a point on it, but I suspect the reason is that when it comes to medical equipment stocks, Morgan Keegan just isn't that great an analyst. According to our records on CAPS, MK actually gets about 71% of its recommendations wrong in this industry. Indeed, the only significant "win" it's booked over the past two years was a November 2009 recommendation of The Cooper Companies (NYS: COO) . Cooper's a stock that still looks pretty attractive today. Cooper has a forward P/E ratio of about 15, yet is growing at better than 15% per year.

Cooper, however, looks to be the exception that proves the rule: Morgan Keegan generally gets it wrong when picking medical equipment stocks, and it's gotten it wrong again this week. It's too pessimistic about Abbott, and not pessimistic enough about Boston Scientific.

Want to learn which health-care stock the Fool -- and Warren Buffett -- think will outperform all others?Read about it in this free report.

At the time this article was published Fool contributorRich Smithdoes not own (or short) any company named above.You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 383 out of more than 180,000 members. The Motley Fool has adisclosure policy.The Motley Fool owns shares of Medtronic, Johnson & Johnson, and Abbott Laboratories.Motley Fool newsletter serviceshave recommended buying shares of Intuitive Surgical, Abbott Laboratories, and Johnson & Johnson, as well ascreating a diagonal call position in Johnson & Johnson.We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors.

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