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.

3 degrees of connection for LinkedIn
Since IPO'ing in May, shares of professional networking site LinkedIn (NYS: LNKD) have lost 20% of their value in a volatile market that has essentially gone nowhere. But according to Wall Street, that's all about to change.

Yesterday, not one, not two, but three major investment banks weighed in with positive reports on LinkedIn. According to JPMorgan, LinkedIn's "growing penetration in the enterprise market" will boost the shares to $84 within 12 months (though that estimate is down from JP's prior projection of $98), and so the company upgraded the stock to "outperform." Morgan Stanley is even more optimistic, predicting an even $100 share price by the end of next year, and looking at the shares' recent "weakness as a buying opportunity as the company appears to be firing on all cylinders in each of its three business segments." Accordingly, Morgan Stanley upped its ratings on the stock to "buy." Meanwhile, Bank of America -- remember it? B of A was already bullish on the shares -- has raised its earnings estimate for the coming year.

Are the bankers right about LinkedIn? And what is it, exactly, that makes them so confident in upping their earnings targets and urging investors to buy the stock?

Need I even say it?
It probably goes without saying, but I'll say it anyway: All three of these investment banks helped to underwrite the IPO. As such, their reputations are on the line if LinkedIn doesn't recover from its slump, and soon. It makes sense, therefore, that they'd all be more than happy to carry water for LinkedIn. That said, let's take the bankers at their word, and see if their arguments hold water, too.

Last time we looked at LinkedIn, it was ace investment banker UBS who gave us the best description of its valuation method on the stock. This time, it's JPMorgan we'll be using as our proxy for Wall Street optimism. According to the banker, LinkedIn will probably collect $86 million in earnings before interest, taxes, depreciation, and amortization (EBITDA) this year, then nearly double that in 2012, to $153.4 million. Not a bad one-year performance, and that's in line with the longer-term estimates that analyst consensus puts at 82% per year for the next half-decade.

A few caveats
So far, fair enough. LinkedIn is growing great guns. But hold up a sec. EBITDA? Why exactly is JPMorgan basing its valuation on this rather arcane bit of accounting? I mean, it's not as if LinkedIn is some profitless Web start-up like Pandora (NYS: P) , Zipcar (NAS: ZIP) , or Groupon (NAS: GRPN) . Unlike those three, LinkedIn is a bona fide net-profit-generating operation. It's just...not very profitable.

And I suspect that's part of JP's problem. I mean, LinkedIn may be far outgrowing rival job facilitators like Monster Worldwide (NYS: MWW) and Gannett (NYS: GCI) -owned CareerBuilder. But with just $10 million in trailing profits to its name, the stock still sports an embarrassingly high P/E ratio -- and wouldn't JP look silly trying to justify recommending a stock with a 700 P/E!

A better way
So let me make a modest suggestion that may help JPMorgan, B of A, and Morgan Stanley out of their dilemma: If the P/E's too high to mention in polite company, and EBITDA is too weird a concept to try and push on your clients, go for something tangible: free cash flow.

You see, in contrast to its all-but-absent net profits, LinkedIn really is a pretty good generator of cash profits already. Free cash flow generated over the past 12 months came to a respectable $43.5 million, and while that's quite not Scrooge McDuck money yet, it is enough to knock the valuation ratio on this one down from four figures to just three: 164 times free cash flow.

Foolish takeaway
Now, would I buy it even at this more down-to-earth valuation? No way, Jose. I don't pay triple-digit valuations for anything, much less for a debatably profitable virtual networking operation that's growing at only a double-digit rate. But the P/FCF valuation is at least sufficiently grounded in fact as to permit honest debate among investors.

It's low enough that, should LinkedIn shares ever reapproach their initial public offering price -- say, about a 50% discount from where they trade today -- the stock might finally become buyable.

Not willing to wait for a 50% drop in LinkedIn's share price? Want to find a stock that's buyable today? Take a gander at the Fool's latest research report: "The Motley Fool's Top Stock for 2012." It's free for the taking.Just click right here.

At the time this article was published Fool contributorRich Smithdoes not own shares of (or short) any stock named above.You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 342 out of more than 180,000 members. The Motley Foolhas adisclosure policy.The Motley Fool owns shares of Zipcar.Motley Fool newsletter serviceshave recommended buying shares of Zipcar.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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