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.

Fired up for steelmakers
Here we go again, folks. For months, we've been tracking Wall Street's headlong rush back into steel stocks, beginning with Deutsche Bank's recommendation to buy AK Steel (NYS: AKS) and U.S. Steel (NYS: X) this past summer on expectations of "steel price and demand inflection." Then a few months ago, Longbow Research joined the party, advising investors to add mini-mill operators Steel Dynamics (NAS: STLD) and Nucor (NYS: NUE) to their shopping lists. By October, the Street was in full-fledged bull-stampede mode. Ignoring warning signs contained in Alcoa's (NYS: AA) weak Q4 forecast, Dahlman Rose went all-in with a bet on the world's largest steelmaker -- ArcelorMittal (NYS: MT) .

And then the stampede screeched to a halt. In the waning weeks of October, we saw Wells Fargo take a far more nuanced view of the steel market -- praising Nucor as the best operator in a lousy industry, but panning AK Steel, Steel Dynamics, and U.S. Steel for their high costs and low prospects. Goldman Sachs even went so far as to suggest selling U.S. Steel.

What, a Fool may wonder, will it take to restart the next bull run in this industry?

Round 2
How about the conversion of a steel skeptic? As I mentioned above, Wells Fargo was one of the first analysts to hop off the steel freight train in October. But last week, StreetInsider.com reported that Wells Fargo has changed its mind, and is now calling "all aboard" for a second round of steel industry optimism.

What inspired Wells' change of heart? StreetInsider doesn't know, and Wells isn't saying. (At least, not publicly.) Chances are, though, that this upgrade was inspired at least in part by AK's recent prediction of 3% steel shipment growth in Q4. And yet...3% sales growth isn't ordinarily something to crow about. Is it enough to justify buying AK today?

What the meaning of "is" is ...
I suspect it all depends on what you think "3%" growth means. Personally, I look at the number and read it as "weak." But steel bulls may look at the same number and call it "better than the 0.6% revenue growth that AK posted in Q3." They may even read 3% as confirmation that the long-awaited "inflection point" in steel demand -- first posited by Deutsche way back in June -- is now at hand.

Even if it is, though, I don't see any pressing need to rush right out and buy AK Steel today in anticipation of this "inflection." Remember, just a month ago Wells Fargo itself panned this company for its high cost structure and poor balance sheet. At $830 million in market cap, AK Steel carries a debt load bigger than the total value of its shares. It's unprofitable today, and valued at more than nine times projected profits for the year to come. Yet analysts who follow the stock believe AK will only grow its "profits" (you know, the ones it's not yet actually earning) at barely 4% per year over the next five years.

Foolish takeaway
If you ask me, paying nine times still-imaginary earnings for 4% growth is a bit optimistic. At a minimum, I'd like to see proof that AK Steel can generate some honest-to-goodness free cash flow, much less GAAP earnings, before wandering into the bull-rushes on this one. (Which, by the way, is just one reason I prefer Nucor over AK Steel.)

But that's just my opinion. What do you think about AK Steel and its prospects? Tell us about it, on Motley Fool CAPS.

On the plus side, one thing AK Steel has going for it is a nice, respectable dividend yield of 2.7%. But even here, we see better opportunities available to dividend investors. Want to find out what they are? Read all about 'em in our new Fool report: "13 High-Yielding Stocks to Buy Today." 

At the time this article was published Fool contributorRich Smithdoes not own shares of, nor is he short, any company named above.You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 357 out of more than 180,000 members. The Motley Foolhas adisclosure policy.The Motley Fool owns shares of ArcelorMittal.Motley Fool newsletter serviceshave recommended buying shares of Nucor.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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