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.

And speaking of the best ...
With a return of better than 50% per pick, versus a 13% average performance by the S&P 500, the team at Motley FoolRule Breakers is one of the better groups of stock-pickers out there. One pick of theirs, however, hasn't worked out so well: Travelzoo (NAS: TZOO) .

Yesterday, the travel-deals-by-email site reported its full-year 2011 earnings. Profits were strong, but gross and operating margins slackened, and Travelzoo also came up short on the revenue side. Crucially, the company argues that it still feels "positive about our Local Deals business," which they say is superior to the offerings at Groupon (NAS: GRPN) , and Amazon.com (NAS: AMZN) supported LivingSocial because Travelzoo focuses on "higher quality deals." Reviewing the results, fellow Fool Rick Munarriz argued that Travelzoo is at least "moving in the right direction, and that's a start ... "

... but not everyone feels the same. In fact, far from a good "start," the analysts at Benchmark argue this morning that momentum at Travelzoo's vaunted Local Deals service is "halted." Downgrading the stock to "hold" this morning, Benchmark observes that Travelzoo's Local Deals revenue seems to have declined 9% sequentially in Q4, and the analyst warns further declines could be "extending into 1Q12." With this service losing ground to Groupon, Amazon, and other deals sites, Benchmark worries that Travelzoo could be held to just a 10% revenue gain in 2012. Combined with weakening profit margins, that would not be good news at all.

Let's go to the tape
Of course, the worst part of all this (from a Travelzoo shareholder's perspective) is Benchmark's record on calls like these. Ranked "99.02" on CAPS, Benchmark is not only in the top 1% of stock-pickers we track -- it's downright the best-ranked, most accurate, best-performing Wall Street analyst I have ever come across in five years of writing this column.

With a record of 68% accuracy, Benchmark is quite literally twice as likely to be right on its stock picks as it is to make a mistake.

How does Benchmark do it? I can only guess, but it looks to me like Benchmark outperforms its peers in part because it has a keen eye for the statistics that matter. For example, in gauging Travelzoo's potential in 2012, Benchmark doesn't just crunch earnings numbers ($1.57 per share, projected), but also proceeds to calculate probable free cash flow at the company ($1.61 per share.)

That's a common characteristic among high-quality stocks -- better free cash flow than reported earnings. It's something you'll find at priceline.com (NAS: PCLN) , a Travelzoo rival, and also a long-time recommendation of Benchmark's, first picked back in August of 2009. (Priceline has essentially quadrupled since Benchmark picked it, by the way, yet still looks cheap today.)

Strong FCF was probably a factor in Benchmark's original endorsement of Travelzoo, too. But at a share price of 32x trailing free cash flow, and long-term growth estimates at just 16.6%, I have to agree with Benchmark that the stock looks a bit pricey now that growth is slowing. Indeed, if Benchmark's right about how 2012 will turn out, we're probably looking at about a 16.5x price-to-free-cash-flow ratio by year-end. While cheaper than the trailing valuation, this still suggests a purchase at today's price will need a good 12 months of growth to reach "fair value."

Foolish takeaway
A lot can happen in a year, of course. Travelzoo could surprise us. It could turn in fiscal 2012 growth closer to the consensus estimates of 18% than to the 10% growth Benchmark is projecting. But working from the numbers we can see, as opposed to the numbers we can only guess at ... I'm forced to conclude that Travelzoo is at best fairly priced today, and at worse still pretty expensive.

Travelzoo had a disappointing quarter, but there are plenty of other companies out there that investors need to watch during this earnings season. In the Fool's "Fourth-Quarter Earnings Report: 7 Stocks You'll Want to Watch," you'll find information on this quarter's possible big performers. It's completely free for our readers, so click here to access your free report today.

At the time this article was published Fool contributorRich Smithdoes not own shares of any company named above, but The Motley Fool owns shares of Amazon.com, andMotley Fool newsletter serviceshave recommended buying shares of Amazon.com, Travelzoo, and Priceline. You can find Rich on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 367 out of more than 180,000 members. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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