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.

Sterne Agee hearts HP
On Friday, as trading wound down for the week, the analysts at Sterne Agee managed to squeeze in one last upgrade before everyone went to bed -- and what an upgrade it was. With time ticking down to Hewlett-Packard's (NYS: HPQ) release of Q3 earnings, Sterne rushed out a recommendation to buy the shares ahead of the news.

What's got Sterne feeling so generous about HP? After all, the company has certainly had more than its fair share of problems of late:

As a result, HP's arguably further behind the curve than it was two years ago. It's made zero headway against Apple (NAS: AAPL) , Google (NYS: GOOG) , or Research In Motion (NAS: RIMM) in the tablet computer wars -- instead running in circles while Amazon.com (NAS: AMZN) and Barnes & Noble (NYS: BKS) raced to market. Heck, HP nearly managed to lose its signature personal computer business in the process!

With all HP's difficulties, Sterne says, Wall Street is expecting new CEO Meg Whitman will need to slash guidance pretty drastically in tonight's report. Word on the Street is that fiscal 2012 guidance could drop from the currently expected $4.60 to as low as $3 a share, and scare the bejeezus out of investors.

Sterne thinks differently: "In our channel and end user checks, the uncertainty clouding the company's PC business has been lifted ... The feedback we are getting is that the decision to keep its PC business has given channel partners and end users relief and giving them comfort in doing business with HPQ again." Consequently, Sterne thinks it's entirely possible HP can earn as much as $4.40 per share in the coming year. And if that's the case, then HP looks "too cheap, trading at 5-6x calendar 2012 estimates."

The upshot
So Sterne's buy recommendation actually comes in two parts. Short term, the analyst acknowledges that "we are making a call in front of the print," hoping that less-bad-than-feared guidance will transform into a bigger-than-expected jump in stock price tonight. But Sterne's also making a "longer term call," arguing there's a "positive fundamental change in the company" afoot. Sterne sees every possibility that once "investors get more comfortable with the company's turnaround plans," they will happily pay as much as eight times earnings for the stock.

If Sterne's right, that would make for a $35 stock price -- and a 30% profit for investors who follow its advice and buy HP today. Is that likely?

One word: No.
As much as I would like to be able to tell you that Sterne Agee is right about its HP happy talk, the fact is that these shares have already rebounded strongly since October. From today's $27 share price, I see little chance of further improvement in either the short or the long term. Here's why.

Right now, HP shares sell for 6.3 times earnings. That sounds cheap, but remember, HP's purchase of Autonomy has saddled the firm with a sizable slug of debt. The company still isn't generating free cash flow at the same levels as its claimed GAAP net profit. Finally, long-term growth estimates -- estimates exclusive of any new bad news that breaks tonight -- are already counting on 7.6% annual earnings growth for the next five years.

That's not a very big margin of safety when you consider all the headwinds HP faces: The cost of rebuilding its tablet computer operation from scratch. The writedowns of its basically worthless Palm purchase. The skyrocketing costs of computer component parts after twin disasters in Japan and Thailand. (Already, we're hearing disturbing reports of supply chain disruptions and higher prices for graphics chips and computer hard drives emanating from NVIDIA, Western Digital, and Seagate.)

Foolish takeaway
Any one of these factors could result in earnings guidance weaker than Sterne Agee hopes to see, and ruin the chances of a short-term pop tonight.

And longer term? Sorry, Fools. But paying 6.3 times earnings for a (questionable) 7.6% growth rate looks like only a fair price to me. It's not cheap. If I were you, I'd seek my bargains elsewhere.

If it's bargains you're looking for, it's bargains we've got. Read all aboutThe Motley Fool's Top Stock for 2011.

At the time this article was published Fool contributorRich Smithowns shares of Google.You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 308 out of more than 170,000 members. The Motley Foolhas adisclosure policy.The Motley Fool owns shares of Apple, Google, Western Digital, and Oracle.Motley Fool newsletter serviceshave recommended buying shares of Apple, Amazon.com, NVIDIA, and Google.Motley Fool newsletter serviceshave recommended creating a bull call spread position in Apple and also writing puts in NVIDIA.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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