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.

Back to the future for FedEx
As you may recall, FedEx (NYS: FDX) shares took a bit of a beating last quarter. Despite "beating estimates" by a penny, management frightened investors with a warning about future earnings and saw its stock drop 8% in response.

But that, as they say, was then. This is now. Long on optimism and short on memory, investors have returned to FedEx stock with a vengeance. Shares that cost just $66 and change a month ago sell for nearly $80 today.

At least one investor sees this as a good reason to get out of FedEx before Mr. Market remembers why he sold off FedEx in the first place. On Friday, Standpoint Research pointed out that if investors "overreacted" to FedEx's earnings warning in September, then the shares' gain of "20% in the four weeks since our recommendation" now leaves FedEx "fairly valued at 15X trailing twelve months earnings and 12X estimates for 2012. In our opinion FDX shares will (at best) track the market from this point forward and the risk reward is no longer attractive in the near term."

I agree. In fact, as you'll see in a moment, I'm probably even more bearish than Standpoint...

Let's go to the tape
But before we get into the case for selling FedEx, let's first run down the reasons why Standpoint is right to at least stop buying the shares. At first glance, I admit that the suggestion is controversial. After all, FedEx shares sell for only 10.8 times next year's earnings estimates. That's cheaper than the average stock on the Dow Jones Industrial Average (INDEX: ^DJI). Cheaper, too, than FedEx's rivals in the rail industry such as Union Pacific (NYS: UNP) or CSX (NYS: CSX) , at 12.6 and 11.4 times earnings, or freight forwarders like Expeditors International (NAS: EXPD) , or UTi Worldwide (NAS: UTIW) , at 22 times earnings, and 14.2 times. Yet FedEx's predicted long-term growth rate compares quite favorably to most of these companies. All in all, a reasonable-seeming valuation.

Regardless, Standpoint's reservations about the stock deserve close attention. Ranked in the top 4% of investors, Standpoint is quite literally one of "the best" analysts we track on Motley Fool CAPS. And while Standpoint has only taken an affirmative buy/sell position on FedEx once in the past few years -- it made the right choice, beating the market by 9 percentage points on that pick.

And I think Standpoint is right again today.

Check's in the mail -- but will it bounce?
What has me feeling so pessimistic about FedEx, despite its strong earnings and seemingly reasonable stock price? Simply put, I'm not sure the earnings are all they're cracked up to be -- or that the stock price is as good as it looks.

Consider: While FedEx claims GAAP earnings of $1.5 billion for the past 12 months, cash profits for the period -- free cash flow -- amount to a mere $573 million. That's barely a third of the reported amount.

Nor is this an isolated incident. Over the last five reported fiscal years, FedEx's combined free cash flow of $2.5 billion was less than half the company's reported $5.8 billion in net income. Valued on the firm's free cash flow, therefore, I see FedEx less as a company trading for "11 times what it might earn next year," than as a company trading for 44 times the amount of cash it actually produced over the past year -- and 50 times what it produces in an average year. This latter valuation may become even more important, if worries of a drastic slowdown in the shipping industry prove accurate.

Foolish takeaway
Call me a skinflint, call me a Fool, but I just don't think FedEx's projected 15% growth rate is speedy enough to justify paying this kind of price for the stock. And while I admit FedEx may grow faster than expected if, for example, predictions of service cutbacks at U.S. Postal Service come to pass, many analysts believe that such cutbacks will work more to the advantage of UPS (NYS: UPS) -- which has a greater scale of operations on the ground -- than to FedEx. Indeed, some pundits suggest downsizing at USPS may put added strain on FedEx, which pays USPS $1.4 billion a year to complete the "last mile" of many of its deliveries.

Net-net, troubles at USPS probably won't move the needle enough at FedEx to make what (I consider) a very expensive stock look cheap. For this reason, I agree with Standpoint that it's best to avoid the stock for now. And yes, if I owned it myself, I'd probably count my blessings at the stock's recovery from its September lows -- and I'd sell it today.

At the time thisarticle was published Fool contributor Rich Smith does not own (or short) shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 316 out of more than 180,000 members. The Motley Fool has a disclosure policy.Rich's reservations notwithstanding, The Motley Fool owns shares of United Parcel Service and FedEx. Also, Motley Fool newsletter services have recommended buying shares of FedEx. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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