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...
I've got bad news for Dell (NAS: DELL) shareholders this morning: Wall Street says your stock is a dog.

Warning that investors in the cut-rate computer maker have gotten "complacent" about Dell's competition, and arguing the shares' 20% run-up this year is "too positive," investment banker Sterne Agee announced Wednesday morning it is downgrading the stock to "underperform."

Why all the pessimism? Employing a lunchroom analogy, Sterne describes Dell as "sandwiched between lower-cost players (Lenovo and Acer)" on the low end, while on the high end, Apple (NAS: AAPL) is "encroaching more in its core PC business as Macs and iPads gain share." Whichever way you look, Dell's rivals are going to eat its lunch.

And it gets worse. The analyst also worries that Hewlett-Packard (NYS: HPQ) , IBM (NYS: IBM) , and Cisco (NAS: CSCO) are all invading Dell's traditional "core market in small-medium business (SMB) and servers." Furthermore, Sterne argues that HP, IBM, and Cisco all sport more attractive "numbers" than does Dell. As a result, Sterne says it would rather own pretty much any name in the tech sphere over Dell -- and urges investors to sell the stock.

Let's go to the tape
Is Sterne right about all this? If so, it wouldn't be the first time... but it would be the second. You see, one of the great things about Motley Fool CAPS is that by tracking the recommendations of analysts like Sterne Agee, and keeping a running tally of their performance, we give you a way to put logical-seeming arguments -- such as the one Sterne makes today -- in context, to let you see for yourself how the analyst's advice has played out in years past. And how has Sterne fared in that regard?

Not well. Fact is, according to our records, over the past couple of years that Sterne's been picking stocks in the Computers and Peripherals industry, it's only been right about one stock (Apple). Every other prediction Sterne has made has been wrong, with the result that the analyst is now 1-for-4 on its computer industry picks. (Don't believe me? Click here, and see for yourself.)

Sell Dell? Are you crazy?
And guess what, Fool? Sterne is wrong again about Dell. Let's crunch a few numbers, really quick, so you can see what I mean:

Company
P/E Ratio
Growth Rate
Free Cash Flow (as a % of net income)
HP8.94.4%114%
Dell9.35.1%123%
Cisco10.68.7%145%
IBM14.810.8%99%
Apple14.919.3%124%

Admittedly, Sterne has a point about some of these companies being better bargains than Dell. Cisco sports a shiny 1.2 PEG ratio, and is even cheaper when valued on its free cash flow. And as I've been saying for years, Apple remains one of the best bargains in tech. (Yes, even at $500 a share.)

On the other hand, though, HP's valuation looks as questionable as ever, while IBM -- great company that I believe it to be -- quite simply costs too much for value investors to spare it a second glance.

But as far as Sterne's sell-Dell argument goes, I just don't think it holds up. At 9.3 times earnings, Dell looks cheaper than Hewlett-Packard, despite possessing a faster growth rate and superior net profit margin. Dell generates greater free cash flow than HP (as a percentage of net income). Indeed, it's basically on par with Apple in this regard. And if you factor Dell's $5.5 billion cash hoard into the equation, I see the stock selling for an enterprise value just six times its annual rate of free cash flow.

Foolish takeaway
Put another way, if you buy a share of Dell today, the company is likely to generate enough cash profit to pay you back your entire purchase price in just six years. And that's if it doesn't grow at all. If Dell manages to leap the low 5% growth hurdle analysts have set for it (or even do better), Dell will pay you back even quicker.

Sterne may think that's an argument for selling the stock. I disagree.

Of course, even if Dell doesn't merit a sell, it's not so obviously undervalued that I'm going to tell you to rush right out and buy it. At this time, I'm only suggesting a "hold" rating is more appropriate. If you're looking for stocks that you can buy today, though, take a look at the Fool's new -- and free! -- report, "3 Hidden Winners of the iPhone, iPad, and Android Revolution."

At the time this article was published The Motley Fool owns shares of IBM, Apple, and Cisco Systems.Motley Fool newsletter serviceshave recommended buying shares of Apple and Cisco Systems, as well as creating a bull call spread position in Apple and writing covered calls in Dell.Fool contributorRich Smithdoes not own shares of any company named above.You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 380 out of more than 180,000 members. The Motley Foolhas adisclosure policy.We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors.

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

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