This Just In: More 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." The pinstripe-and-wingtip crowd is entitled to its opinions, but we have some pretty sharp stock pickers down here on Main Street, too. And we're not always impressed with how Wall Street does its job.
So 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. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.
Red clouds, silver lining
It's shaping up to be another red day for Mr. Market, but not all investors are crying in their coffee. In fact, shareholders of Oracle (NAS: ORCL) are grinning ear-to-ear, as their stock receives its second-in-a-row upgrade.
Last week, as you may have heard, the smart stock investors at Nomura Securities initiated coverage of Oracle with a "buy" rating. This week, it's an even higher-profile analyst, Goldman Sachs, that's lifting Oracle to higher heights as it anoints the stock a "conviction buy." But why?
Oracle knows all
StreetInsider.com reports that Nomura is recommending Oracle as "one of the best-positioned vendors for vertical integration [with] a compelling risk / reward given its integrated stack offering, increasing customer traction of its Exadata and Exalogic systems, margin expansion opportunities, and current valuation near the low end of its 5-year range." Nomura continues: "Specifically, we look for the company's hardware operations to drive margin upside, and our analysis points to higher hardware support attach rates that should double from current levels. Oracle's OpenWorld 2011 in early October should act as a near-term catalyst given expected positive customer testimonials on its new product offerings."
Goldman, in contrast, keeps it simple: "Oracle trades at 11X [next year's earnings], which compares to its five-year average of 15X." And for those who fear that Oracle could suffer if the United States falls into recession, Goldman reassures us that even "during the financial crisis [Oracle shares sold for] 9.4X" earnings, meaning, worst case, we're looking at only about "12% downside" from here.
But is Goldman right?
Let's go to the tape
I admit, Goldman doesn't have the shiniest record on software stocks. Over the several years we've been tracking its progress, this banker is scoring only about 41% for accuracy in the industry. Lately, however, Goldman's been on a bit of a hot streak in software. Of the dozen recommendations it currently has active in the industry, fully 61% are outperforming the market -- including the December 2009 "buy" recommendation on Oracle that Goldman just upgraded to a "conviction buy." And call me a crazy optimist, call me a Fool, but I think Goldman's right to stick with this winner.
Why? Well, it's true that Oracle appears pricey on the surface. Its 15.6 P/E ratio makes the stock more expensive than the average Dow Jones Industrial Average (INDEX: ^DJI) megacap. Oracle's also more expensive than software peers IBM (NYS: IBM) or Adobe (NAS: ADBE) , which fetch 13 times earnings apiece. It's pricier than Microsoft (NAS: MSFT) at 10, and it's way more expensive than aspiring software-makerHewlett-Packard (NYS: HPQ) . Among the big coders, Oracle really only appears "cheap" when you compare it with triple-digit-P/E'd salesforce.com (NYS: CRM) .
But appearances can be deceiving. When evaluated on its own merits, Hewlett-Packard's 15.6 P/E ratio doesn't look too off the mark when you note that most analysts have it pegged for 15% long-term profits growth. Toss in a modest 0.9% annual dividend, and the shares actually look reasonably priced ... and they could be even cheaper than they look.
Oracle earned "only" $8.5 billion in GAAP net profit over the past year, but according to its cash flow statement, the company actually generated $10.8 billion in free cash flow. Back out Oracle's net cash position, and value the company on this free cash flow, and what you get is a company selling for an enterprise value of just 11 times annual free cash flow -- not a bad price for a 15% grower. Not bad at all.
Goldman isn't the most accurate purveyor of software picks, but in Oracle I think it's found a winner. The company is cash-rich, free cash flow-robust, and selling for about a 28% discount to what its shares fetched just four months ago. If you ask me, it's a bargain.
At the time this article was published Fool contributorRich Smithowns no shares of any company named above. You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 410 out of more than 180,000 members.The Motley Fool owns shares of IBM, Oracle, and Microsoft.Motley Fool newsletter serviceshave recommended buying shares of Microsoft, salesforce.com, and Adobe Systems, creating a bull call spread position in Microsoft, creating a diagonal call position in Adobe Systems, and shorting salesforce.com. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.
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