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." The pinstripe-and-wingtip crowd is entitled to its opinions, but we have some pretty sharp stock pickers down here on Main Street, too. And we're not always impressed with how Wall Street does its job.

So perhaps we shouldn't be giving virtual ink to "news" of analyst upgrades and downgrades. And we wouldn't -- if that were all we were doing. Fortunately, 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.

Lighting up the stock market
And speaking of analysts who (sometimes) know what they're talking about, lit up the stock market Friday with a series of initiations on LED stocks. For years, we've seen LEDs popping up everywhere from inside flashlights to television sets to automobile tail lights. But now Goldman's calling "general lighting" the "multidecade opportunity paving the next phase of LED growth."

Niche products are all well and good, you see, but the operative word in "light emitting diodes" is, after all, light. And according to Goldman, it's the wholesale replacement of incandescent and fluorescent bulbs with LED lights that offers "the most upside in LED stocks." The analyst argues that by 2015, LED lighting will be "an $11 billion revenue opportunity," which will proceed to "grow at 30%+ unit CAGR through 2020."

Winners ...
So who will the winners to be in this nascent, luminescent revolution? Goldman thinks the biggest, most immediate opportunity can be found at Cree (NAS: CREE) , which boasts "superior technology" to its "commoditized rivals," along with profit margins that are "underappreciated in Street numbers." Farther out, Goldman expects Cree to give way to Universal Display (NAS: PANL) , which owns the "dominant technology" in organic light emitting diodes and will deliver "high returns" to investors.

... and losers
Less attractive, in Goldman's view, are Veeco Instruments (NAS: VECO) , which makes the MOCVD equipment that's used to manufacture LEDs. Perhaps strangely for an analyst so bullish on LEDs generally, Goldman argues that "demand for MOCVD tools" is "moderating." If correct, this suggests that Veeco may not grow as rapidly as some investors would like. (On the plus side, Goldman has nothing but praise for Veeco's strong balance sheet and free cash flow prowess). Put it all together, and the worst Goldman will say about Veeco is that it's neutral on the stock.

"Neutral," however, would be an improvement for Rubicon Technology (NAS: RBCN) . At less than 5 times earnings today, the stock looks cheap. But Goldman warns that looks can be deceiving: The provider of raw materials for LED manufacturing suffers from "prolonged pricing weakness and high capital intensity."

Is Goldman right?
When it comes to picking stocks, Goldman has proved itself anything but infallible. In fact, according to our CAPS stats, the banker ranks in the bottom 20% of investors we track today -- hardly the impression Goldman likes to convey. So rather than just take the analyst at its word, let's give its recommendations a quick look-over and see whether the numbers add up. We'll start with the easy ones.

Rubicon Technology and Veeco Instruments
I'm as big a sucker for a low price-to-earnings ratio as other any value investor, and Rubicon's 4.7 P/E certainly qualifies. But this company hasn't generated positive free cash flow ... ever. And it burned more cash than ever in 2010. Goldman's right to counsel selling.

Similar story with Veeco Instruments. I own the stock, and I agree with Goldman about the company's robust balance sheet and positive free cash flow. The latter sets it apart from -- and, I'd argue, makes it superior to -- Germany's Aixtron (NAS: AIXG) . But Veeco's free cash has been dwindling of late, and with its price-to-FCF ratio of nearly 60 today, I see no burning need to double down on a company that's already trending down.

Universal Display
This one's trickier. According to Goldman, it's the long-term winner in lighting, but I'm not sure what Goldman means by "long." The company's unprofitable today and sells for 51 times next year's projected earnings -- but it's expected to grow its profits at only 24% or so annually over the next five years. Free cash just turned positive and could outgrow earnings, but right now I think the stock's still pretty much a crapshoot. It could go to the moon, but it could also crash and burn at any signs of disappointment in the growth story. At today's price, U-D is too rich for my blood.

Cree
Goldman's nearer-term favorite, in contrast, may hold more promise. Goldman sees Cree growing 30% per year for the next decade, but Goldman's in the minority on that. Most Wall Street analysts expect Cree to grow at closer to 22% per year over the next five years. If they're right, the company's $101 million annual net income suggests that Cree may be overvalued at a P/E of 29. When you consider that Cree is also a net burner of cash, I have to say I'm less enthused about the company's prospects.

What's a Fool to do?
The good news is that there are safer ways to play Goldman's long-term bullish LED thesis than through investing in these speculative companies. General Electric (NYS: GE) , for example, has publicly said it expects LEDs to eventually make up 75% of its lighting sales in the future. I wouldn't be surprised to see Germany's mini-GE -- Siemens (NYS: SI) -- take a similar path. At 12 and 10 times earnings, respectively, these two companies offer a safer, more diversified way to benefit from the growth of the LED industry.

Neither one's going to double overnight. But neither one's going to go broke betting on the next big thing, either. And with their steady dividend yields of 3.8% and 2.8%, respectively, you won't go broke either.

Not all start-ups are doomed to wind down. Not all small caps go broke. If you want to bet on a potential double, with half the risk, read the Fool's new -- and free! -- report titled "Too Small to Fail: Two Small Caps the Government Won't Let Go Broke."

At the time this article was published Fool contributorRich Smithowns shares of Veeco Instruments. You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 308 out of more than 180,000 members.Motley Fool newsletter serviceshave recommended buying shares of Universal Display. 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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