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.

How high can an Apple bounce?
After a week of wailing and lamentation comes the rejoicing. For days, market watchers have fretted over the inexplicable decline in Apple (NAS: AAPL) shares. Sure, they were up 75% or so from a year ago, but last week Apple experienced a near-unprecedented (to those with short-term memory loss) five-day losing streak. And Apple's sudden subjection to gravity, reported The Wall Street Journal, was starting to make investors "freak out."

Well, not to worry. As analyst Raymond James announced yesterday, the drawback at Apple was actually just a buying opportunity.


Initiating coverage of a stock it had previously eschewed, RJ argued that not only had Apple become cheap, but it had become so cheap that investors willing to defy the laws of gravity stood to make a good 33% profit on the stock by buying on the pullback. The analyst declared Apple a "strong buy" and predicted its shares would hit $800 within a year -- and not just Apple...

Smartphones uber alles
Turns out, Raymond James is uber-bullish on a lot of things tech. In addition to Apple, the analyst initiated at least three other tech stocks with optimistic ratings yesterday:

  • Qualcomm (NAS: QCOM) rated at outperform.
  • Digi International (NAS: DGII) also rated at outperform.
  • Motorola Solutions (NYS: MSI) -- which, now that Google has bought Motorola Mobility, I suppose we can just call "Motorola" again -- rated at "strong buy."

With your permission, I'll skip right by Raymond James' Apple endorsement today. I think the bull thesis on this one has been pretty well-covered by other writers already. (In fact, I'd say the horse is well and truly dead, and the cause of death is blunt-force trauma).

But what about RJ's other recommendations this week -- Qualcomm, for example? On the one hand, it's levered to the explosive growth of the smartphone market. But if you think it makes sense to pay 26 times earnings, or even just 20 times free cash flow, for a stock that no fewer than 33 separate analysts are covering, and which most people agree won't grow faster than 16% per year for the foreseeable future, then nothing I can say will convince you otherwise.

Motorola Solutions? Once upon a time, I probably would have approved of this pick. With everyone focusing on Motorola's spinoff of its sexiest products last year, no one paid much attention to "rump Motorola," Motorola Solutions. That's why I publicly recommended that investors buy MSI back in the summer of 2011, and I'd argue it's also why the stock went on to beat the market from there. Since I closed out my Motorola recommendation, however, the stock has basically treaded water, actually dropping a bit as the market rose. And today the stock still looks fully priced at more than 17 times free cash flow, with a growth rate that's not expected to exceed 15% per year anytime soon.

This leaves us with just one stock to consider today: Digi International, a little-known maker of machine-to-machine networking products.

Can you Digi it?
Digi International may be little-known, but it's well-appreciated. On Motley Fool CAPS, more than 100 investors have come to the collective conclusion that Digi is a five-star (out of five) investment prospect and one of the best bargains on the planet today. And Digi is gaining fans both small and large.

CAPS member JohnStuartMill, for example, points out:

[Asset manager BlackRock] is a current 7.79% owner of this company. This is a recent event (December 2011). DGII has additional big-time holders of Riverbridge Partners, Royce & Associates, and Dimensional Fund Advisors comprising more than 35% of outstanding shares [and] Vanguard and Goldman Sachs.

Little surprise there. While Digi might look expensive on the surface at 30 times earnings, at least two facts argue in favor of this stock being a real bargain in disguise. First off, nearly $100 million of Digi's market cap consists of cold, hard cash. Back that out of the valuation, and the stock's enterprise value is actually just $187 million, or less than 20 times earnings -- not bad for a 25% grower. What's more, Digi is actually even more profitable than it lets on. While GAAP earnings at the company amounted to just $9.4 million last year, actual free cash flow was more than 45% higher -- $13.7 million, resulting in an enterprise value-to-free-cash-flow ratio of just 13.6.

Foolish takeaway
Digi International may not have the high profile of an Apple or Qualcomm. It may lack Google's treasure trove of smartphone tech, DVRs, and patents that came with the purchase of Motorola Mobility, and it hasn't achieved the name recognition of what remains of "Motorola," either. But with an EV/FCF ratio barely half of its projected growth rate, Digi International looks like a real bargain to me -- enough so that I'm prepared to join the CAPS majority today and publicly rate this stock an outperformer.

Think I'm wrong? Follow along and find out.

If you're looking for more unconventional ways to invest in tech, read the Fool's new (and free!) report. Find out how you, too, can profit from "The Next Trillion Dollar Revolution."

At the time this article was published Fool contributorRich Smithdoes not own or short shares of any company named above. You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 362 out of more than 180,000 members. The Motley Foolhas adisclosure policy.The Motley Fool owns shares of Qualcomm and Google. The Fool owns shares of Apple.Motley Fool newsletter serviceshave recommended buying shares of Apple, BlackRock, Google, and The Goldman Sachs Group.Motley Fool newsletter serviceshave recommended creating a bull call spread position in Apple.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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