This Just In: Upgrades and Downgrades


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.

Could F5 "go to 11?"
Shares of communications equipment maker F5 Networks (NAS: FFIV) have lost 43% of their value over the course of this year. Within the communications equipment industry, they've underperformed pretty much any other company you can name, with the possible exception of Ciena (NAS: CIEN) .

Yet, when picking a name to recommend in the industry yesterday, ace stock picker Stifel Nicolaus chose not relative outperformerAlcatel-Lucent (NAS: ALU) , surprise bounce-backerCisco (NAS: CSCO) , or even hard-hit Juniper (NAS: JNPR) or Ciena. It chose F5. Why?

According to Stifel, it all comes down to valuation -- and risk. Subjecting F5 to a "stress test" this week, Stifel determined that if every bad thing possible should happen to F5, if the whole global economy goes into the tank a la 2008, the very worst that can happen to F5 is that the company might earn only $3.50 per share next year. That's about a dollar less than Stifel thinks the company will earn, mind you. And Stifel doesn't really expect that everything bad will happen to F5. But if it does, that's about the worst we can expect to see next year: $3.50 per share in earnings; a forward P/E of 20 on the stock.

Are you scared yet?
According to Stifel, that's simply not a very scary prospect for F5. Whatever bad news one single year may bring, the average analyst agrees that if you can hold through the lean times, even a 20 P/E'd F5 will resume growing and increase earnings at a rate of 22.5% per year over the next five years. Stifel seems to agree this is likely. The analyst cites "several catalysts" that could work in the company's favor, chief among them the new "Victoria" upgrade based on Intel's (NAS: INTC) "Romley" chip due out next year, which could require server operators to buy bigger capacity delivery controllers from F5.

Let's go to the tape
But is Stifel right about F5's prospects? If so, it wouldn't be the first time. Actually, this analyst has recommended buying F5 on two other occasions over the past five years -- and been right both times, outperforming the S&P 500 by a combined 76 percentage points on the two picks.

Call me an optimist, call me a Fool, but I think Stifel's going to win this week's bet as well.

F5: Buy the numbers
I admit that on the surface, F5 doesn't look like a great bargain. The stock's 27 trailing P/E ratio makes it look twice as expensive as Cisco, Juniper, and Alcatel. But consider: According to its cash flow statement, F5 is actually quite a bit cheaper than it looks. While GAAP earnings at the company total just $222 million for the past 12 months, F5's free cash flow for the same period is nearly $360 million -- more than 60% higher than reported income.

That means that a stock that many investors think of as "27 P/E" actually costs something more like 16.5 times actual free cash flow. If F5 can come anywhere close to meeting consensus forecasts for 22.5% long-term growth, the stock's a screaming bargain at today's prices.

Foolish takeaway
Whether you value F5 on Stifel's "worst-case" scenario for the future, or take my more bare-bones approach of dividing trailing free cash flow by expected growth rate, F5 looks cheap. Add in the fact that F5 boasts more than $585 million in net cash on its balance sheet, and not a drop of debt, and I'd argue the stock is even cheaper than that.

Stifel's right to recommend buying it. I'd give (and I will give) serious thought to taking Stifel's advice.

At the time thisarticle was published Fool contributorRich Smithdoes not own (or short) any company named above.You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 383 out of more than 180,000 members. The Motley Fool has adisclosure policy.The Fool owns shares of and has bought calls on Intel. The Fool owns shares of and has created a bull call spread position on Cisco Systems.Motley Fool newsletter serviceshave recommended buying shares of Intel and Cisco Systems.Motley Fool newsletter serviceshave recommended creating a diagonal call position in Intel.We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors.

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