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.

Up is down and bad is good
Lately, it seems that when our economy's too good, that's bad news -- because, pundits say, the government might decide to take the training wheels off and allow companies to succeed or fail on their own. Conversely, when the economy's lousy, that's good news. It means the Federal Reserve might launch "QE3" in an attempt to save stocks. It's a crazy, mixed up world we live in.

In illustration, witness the kerfuffle concerning Juniper Networks (NAS: JNPR) . Yesterday, UBS issued a report warning that slow growth in the global economy may force Juniper to cut 10% of its workforce. Now, to most folks, hearing a company is laying off employees probably sounds like bad news. The way Wall Street looks at these things, however, pink slips for workers mean green days for investors -- because a company that signs fewer paychecks is "cutting costs" and boosting profits. For its part, UBS proposed another possibility entirely: first agreeing layoffs are good for profits, UBS nevertheless worried that losing good people would weaken Juniper in the longer term. Result: The analyst cut a penny off Juniper's earnings estimate for 2012, and slashed its price target 23%.

Juniper moved quickly to discredit UBS' report, however, calling "rumors today of a 10% reduction to our workforce ... grossly overstated and inaccurate." So which is it, Juniper? Are you taking steps to repair profits, or aren't you? And if Juniper really isn't planning layoffs, then perhaps UBS will change its mind and upgrade Juniper shares now?

Let's go to the tape
Investors would certainly welcome that. On the other hand, maybe what they should really be hoping for is a downgrade. Believe it or not, that might be the best news for shareholders.

Why? Because UBS has a perfectly miserable record of picking winners and losers in the communications industry. Over the five years we've been tracking its performance at CAPS, UBS has gotten only about 34% of its guesses right, including gaffes such as:

Company

UBS Rating

CAPS Rating
(out of 5)

UBS's Picks Lagging S&P by

Alcatel-Lucent (NYS: ALU) Outperform**28 points
Ciena (NAS: CIEN) Underperform**27 points (picked twice)
Corning (NYS: GLW) Outperform*****25 points (picked twice)

The analyst is literally almost twice as likely to be wrong on any given pick, as it is to be right. In fact, even UBS' record on Juniper itself looks questionable today. While correctly calling Juniper a buy three times in the last four years, UBS has steadfastly urged investors to hold the stock as it lost half its value over the last five months.

Perhaps then, instead of following UBS' advice and refraining from buying a "fairly valued" Juniper, what we should really be doing is using UBS as a contrarian indicator. Because it seems to me that in calling Juniper a "$24 stock," and a "hold," UBS is missing out on a real bargain.

Consider: At 21 times earnings, Juniper may not look like much of a bargain. Sure, it looks cheaper than Aruba (NAS: ARUN) or Riverbed (NAS: RVBD) , for example. But today, you can arguably pick up even better values at either Alcatel or Cisco (NAS: CSCO) -- which sell for 16 times and 13 times earnings, respectively. On the other hand, most analysts agree that Juniper will outgrow both Alcatel and Cisco -- and Ciena and Corning as well for that matter -- over the next five years, expanding its earnings at the rate of 17.5% per year.

The story gets even better the deeper you dig. Examine Juniper's cash flow statement, for example, and you'll find the company generates significantly more free cash flow ($842 million) than it reports as net income under GAAP ($570 million). Turn to the balance sheet, and you'll see that Juniper has amassed a pile of cash $2.5 billion deeper than its debt obligations.

Foolish takeaway
Put these numbers together, mix briskly, and what you wind up with is a business selling for an enterprise-value-to-free-cash-flow ratio of less than 11 -- but growing at 17.5% per year. To me, that looks like a bargain -- and UBS looks crazy to be reducing its price target on a stock this cheap.

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. 430 out of more than 180,000 members. The Motley Fool has adisclosure policy.The Fool owns shares of and has created a bull call spread position on Cisco Systems.Motley Fool newsletter serviceshave recommended buying shares of Riverbed Technology, Corning, and Cisco Systems.Motley Fool newsletter serviceshave recommended writing puts in Riverbed Technology. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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