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

Given this, 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.

The nattering nabobs of Netflix
On Tuesday, beleaguered movie hawker Netflix (NAS: NFLX) announced it is issuing $400 million worth of bonds and convertible debt in an effort to raise cash to keep growing its business. Streaming actual flicks out over the Internet is a bit more expensive than merely mailing red envelopes via the U.S. Postal Service, you see. And if Netflix wants to pay the rising cost of acquiring digital distribution rights for its customers, it's going to need to fatten its wallet. Unfortunately, this latest round of wallet-fattening is slimming down the stock price ... and eroding its support on Wall Street.

Yesterday, ace analyst Canaccord Genuity reacted to Netflix's latest announcement by reinitiating coverage of the stock -- and telling investors to sell it. Canaccord sees a whole series of problems at Netflix today, ranging from:

  • "accelerating subscriber losses"
  • to "rising content costs"
  • to an "increased competitive landscape" replete with better-funded rivals such as Wal-Mart (NYS: WMT) , Apple (NAS: AAPL) , and Amazon.com (NAS: AMZN) .

Come to think of it, we'd better add Hulu to that list. While a small fry on its own, the company has big backing from co-owners Disney (NYS: DIS) , Comcast (NAS: CMCSA) , and News Corp. (NAS: NWSA) . All in all, a tough row to hoe -- but is it bad enough to justify a sell rating? Honestly, I don't think so, and I'll tell you why.

Netflix: Horror film or feel-good flick?
I won't sugarcoat this, Fools: Next year is going to be a rough one. Netflix has already told us it's probably going to lose money for the year as it spends heavily to acquire streamable content for its library. Canaccord thinks things could get even worse than that, predicting not just "consolidated losses," but also "potential negative Street estimate revisions" (i.e., lower projected growth rates) and "negative cash flow." The analyst hypothesizes as big as a $120 million outflow over the next two to three quarters.

Yet I can't shake the feeling that investors like Canaccord have gotten too negative on Netflix. Remember that even after all the troubles Netflix went through this year, it still managed to generate strong positive free cash flow from its business -- roughly $295 million over the past 12 months. Sure, building a network to provide DVDs and streaming services in Europe and Latin America will cost money in the short term. But as we've seen in the U.S., once the infrastructure is laid down, this business can be very profitable over the longer term.

Third time's the charm (or was that "harm"?)
Right now, Netflix shares sell for about 12.5 times annual free cash flow and 16 times earnings. If Wall Street is right about the company, then whatever happens next year, the next five years should see Netflix grow at better than 23% per year. To me, the price looks cheap in light of that growth rate.

That's why today, I'm going to climb way out on a limb and make my third successive recommendation on Netflix. For those keeping score at home, I've already rated Netflix an underperform once (and racked up a 50-percentage-point win over the market when Netflix finally fell out of favor), then spun on a dime and predicted the company would outperform panicked predictions of a collapse (that one outperformed the market by 16 points -- thanks for asking). Today, I'll try for the hat trick and predict that post-Canaccord-downgrade, and post-debt-issuance, Netflix will prove the skeptics wrong again.

As always, I invite you to follow along on CAPS, hold me accountable for this call -- and heckle loudly if it all goes horribly wrong. Fingers crossed...

Looking for a way to invest in the stock market that's a little less ... shall we say, exciting than an investment in Netflix? Read the Fool's new -- and free! -- report "3 ETFs Set to Soar During the Recovery."

At the time this article was published Fool contributor Rich Smith does not own shares of, nor is he short, any company mentioned above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 309 out of more than 180,000 members. The Motley Fool has a disclosure policy.The Motley Fool owns shares of Wal-Mart Stores and Apple. Motley Fool newsletter services have recommended buying shares of Amazon.com, Apple, Netflix, Walt Disney, and Wal-Mart Stores. Motley Fool newsletter services have recommended creating a bull call spread position in Apple. Motley Fool newsletter services have recommended creating a diagonal call position in Wal-Mart Stores.We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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

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