This Just In: More 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.

Was I wrong?
Last month, I had harsh words for investment banker UBS on the subject of its AMD (NYS: AMD) upgrade -- and I think rightly so. AMD in late September was a company facing stiff competition from mobile semiconductor firms like ARM Holdings (NAS: ARMH) and Qualcomm (NAS: QCOM) on one hand, struggling to win share from market behemoth Intel (NAS: INTC) on the other -- and burning cash on both fronts as it tried to keep up. "Free" cash flow had in fact just hit negative $505 million. Analysts were forecasting a decline in company earnings. But, my, what a difference a month makes.

Last week, AMD shares popped on an earnings beat of real magnitude. The company reported only 4% sales growth and flat earnings -- true. But the $0.15 that AMD did earn was a good 50% ahead of analyst estimates. (So I guess I wasn't the only one surprised here.) Best of all for shareholders, after hearing the news, ace semiconductor analyst Wells Fargo rushed to give its stamp of approval to AMD. And if truth be told, I'm starting to have second thoughts myself.

Let's go to the tape
One key reason I jeered last month's UBS recommendation, as you may recall, was the analyst's anemic record in the semiconductor space. (As I recall, UBS was polling 45% accuracy at the time.) But not so with Wells Fargo. In Wells, AMD bulls finally have an ally with real heft behind it.

According to our supercomputer, Wells ranks in the top 10% of investors we track here at CAPS. And unlike UBS, it's simply superb in semis. Over the four years we've been monitoring its performance, Wells' semi picks have managed to outperform the S&P 500 73% of the time. The analyst racked up notable "wins," for example, on its recommendations of Analog Devices (NYS: ADI) in 2007 and Altera (NAS: ALTR) in 2009 -- and even read the tea leaves right at AMD archrival Intel:

AlteraOutperform****87 points
Analog DevicesOutperform****28 points
IntelOutperform*****22 points


And while I'm not yet fully convinced that Wells will win again with its AMD pick, I'm beginning to rethink my pessimism about the stock. Here's why:

On the surface, the argument in favor of AMD looks pretty obvious. The stock trades for 10.3 times forward earnings, which is a slight discount to the average 11.1 forward P/E on the Dow Jones Industrial Average (INDEX: ^DJI). Yet at the same time, analysts project a near 11% growth rate for AMD -- faster than you'll find from the Dow.

Wells notes that, reading between the lines of AMD's earnings release, the company appears to have "gained discrete graphics share in the most recent quarter." Further bolstering revenues, Wells says "AMD's microprocessor ASP rose" last quarter. Meanwhile, on the cost side, Wells praises AMD for its "ability to hold down operating expenses," saying such cost controls give it "confidence in the company being able to remain profitable and generate cash as it moves through the current soft patch." [Emphasis added.]

Foolish takeaway
I emphasize those two words above for a reason: Historically, my biggest objection to investing in AMD was the firm's near-certain inability to generate free cash flow in any given year. This troubling trend, however, may be changing. Already, AMD has put together back-to-back free cash flow-positive quarters. At last report, operating cash flow for the past 12 months was nearly break-even, while capex is also at historically low levels.

The company's not out of the woods yet, mind you. AMD's still burning quite a bit of cash, and to my mind, this means it's nowhere near as profitable as its $1 billion in reported "GAAP" profits make it seems. But it's getting there. Just in time for Halloween, AMD may be coming back from the dead.

Like investing it unpopular stocks with upside potential? AMD's not the only one out there, you know? Read about another supposedly "unprofitable" company, that could turn into a superstar, in our new -- and free! -- Fool report: "The Tiny Gold Stock Digging Up Massive Profits."

At the time this article was published Fool contributorRich Smithdoes not own shares of any company named above. You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 364 out of more than 180,000 members. The Motley Fool owns shares of Intel and Qualcomm; and has bought calls on Intel.Motley Fool newsletter serviceshave recommended buying shares of and creating a bull call spread on Intel. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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

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