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." 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.

And speaking of the best ...
When it comes to making predictions in the oil patch, few analysts have the kind of Street cred that boasts. Say what you will about this banker's morals, its political entanglements, or even its miserable trading results of recent quarters -- these are still the guys who predicted $100 oil when no one else imagined it could get there (and were right!) And now Goldman's back on the soapbox, loudly declaring who's hot, and who's not, in Big Oil.

Big oil-field services, to be precise. Arguing this morning that "rig demand has just entered the second phase of a multi-year pick up," Goldman quickly rushed out upward of a dozen new ratings on some of the biggest names in "energy equipment and services." And while most of these so-called recommendations were pretty weak tea ("initiating at neutral"), at least a few are worth more careful consideration.

  • Baker-Hughes, Halliburton (NYS: HAL) , Patterson-UTI (NAS: PTEN) , and Weatherford International (NYS: WFT) were among those earning ratings of "buy," or the even more enthusiastic "conviction buy."
  • Transocean (NYS: RIG) and Diamond Offshore got dissed with new "sell" ratings, according to StreetInsider.
  • But such high-profile names as Hercules Offshore (NAS: HERO) and Schlumberger (NYS: SLB) were rated only neutral.

What separates Goldman's supposed winners from its losers and also-rans? Let's find out:

Company

P/E

Growth Rate

Free Cash Flow as a % of Net Income

Weatherford4246%NM*
Baker-Hughes1232%NM*
Halliburton1226%16%
Patterson-UTI1124%NM*
TransoceanNM*2%NM, but in a good way**
Diamond Offshore87%64%
Hercules OffshoreNM*2%NM, but in a good way**
Schlumberger2224%51%

Source: S&P Capital IQ, Yahoo! Finance. 
*Not meaningful due to negative net income or free cash flow over past 12 months. 
**Not meaningful due to negative net income and positive free cash flow.

The capital-intensive oil services business poses some puzzlers. Transocean and Hercules Offshore are both GAAP-unprofitable, but generate positive free cash flow. Transocean churned out more than $900 million in real free cash flow over the past year; Hercules, $24 million -- less impressive, but still better than a loss.

Can it really be this easy?
Seems to me, the reason for Goldman's optimism about its top four stocks -- Weatherford, Baker, Halliburton, and Patterson-UTI -- fairly jumps off the page. With growth rates ranging from modestly higher than reported price-to-earnings ratios (Weatherford) to vastly better (Baker), each of these oil-field services operators boasts a PEG ratio guaranteed to induce drool in the most conservative of value investors. (This does, however, raise the question of why Schlumberger didn't make the cut.)

In short, if it's hypergrowth earnings prospects and a low stock price relative to reported earnings that Goldman's after, then, yes, I think I can see why these stocks would appeal to it. And I can understand why a lot of investors might approve of the new "buy" ratings.

Honey, who shrunk the cash?
That said, while I think I can see where Goldman is going with these recs, that doesn't mean I agree with them. Why not? Quite simply, because even if Goldman is right about prospects for the oil industry in general, I'm not convinced it's making the right bets on which companies will profit from an increase in drilling activity. (I'd also point out that this would fit right in with Goldman's historical record on picking oil-field services companies -- an industry where the analyst scores a surprisingly low 29% record for accuracy.)

None of Goldman's favorite recs scores particularly high in the free cash flow department. (To the contrary, three of the four are burning cash.) In contrast, the analyst's less favorite stocks are all free cash flow positive; maybe not growing great guns, but at least growing cash-profitably. If I were making the ratings, I'd prefer to go with a company that scores high on P/E, growth, and free cash flow. Someone like...

National Oilwell Varco
Notable for its absence from Goldman's list of top picks, National Oilwell Varco boasts a low P/E (16), a high growth rate (also 16%), and superb free cash flow ($1.9 billion -- actually superior to reported net income). Heck, National Oilwell even pays a dividend!

My advice: If it's oil stocks you're interested in, buy the best -- National Oilwell Varco -- and forget the rest.

Or even better, buy The Motley Fool's favoritethree stocks for $100 oil.

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. 335 out of more than 180,000 members. The Motley Foolhas adisclosure policy.The Motley Fool owns shares of Transocean and National Oilwell Varco.Motley Fool newsletter serviceshave recommended buying shares of National Oilwell Varco and Hercules Offshore.We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors.

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

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