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.

One order of Thai takedown
It's been a pretty good quarter so far for the computer and smartphone makers, and the companies who supply them. Android maker Google (NAS: GOOG) utterly destroyed earnings estimates, while its soon-to-be-subsidiary, Motorola Mobility (NYS: MMI) , earned twice what it was expected to. Apple's (NAS: AAPL) iPhone 4S is a definite hit. Elsewhere, TriQuint (NAS: TQNT) beat by the proverbial penny, and SanDisk (NAS: SNDK) hit it outta the proverbial park. But with NVIDIA's earnings due out late next week, one analyst at least thinks it's time to count our winnings and move on, and not press our luck by buying any more NVIDIA (NAS: NVDA) stock.

The analyst: Canaccord Genuity. The rating: "hold."

You see, according to Canaccord, the smartphone market is starting to look a little overheated, showing signs of "overbuild." As early as December, Canaccord worries we could begin to see "demand from smartphone customers waning." Elsewhere, the analyst sees "poor tablet sell-through," while PCs look to be "generally weak ... in 2012." Topping it all off, the effects of massive flooding in Thailand are a big unknown, and one approaching the order of the aftereffects of the Fukishima Daiichi disaster in Japan. So, fearing "supply chain disruptions" may be in the offing, Canaccord argues that discretion is the better part of value investing; it's pulling its buy rating from NVIDIA, and cutting its price target to $15 per share.

I think that's a mistake.

Let's go to the tape
If so, it won't be the first time Canaccord has goofed on its semiconductor picks. Fact is, over the five years we've been tracking this analyst's performance, Canaccord Genuity has only managed to beat the market on about 47% of its recommendations -- making it less accurate than a coin flip. Canaccord's been wrong on ON Semiconductor and wrong on AMD. For that matter, the last time Canaccord made a positive recommendation on NVIDIA, it underperformed the market by 27 percentage points.

Yet today, this same analyst tells us NVIDIA is overvalued? Is there any reason to believe that?

NVIDIA: Buy these numbers?
I mean, I suppose you can make a case for overvaluation if you try. NVIDIA stock today trades for about 16 times earnings, versus estimates of 15% long-term growth. Canaccord notes that relative to its peers, NVIDIA also looks slightly overpriced at "14x our C2012 estimate for EPS, versus a median multiple of 13x for our coverage universe." (A universe that, I might add, includes a whole bunch of semiconductor stocks Canaccord has been wrong about.) For that matter, you can also criticize the P/E for being more than what the average stock on the Dow Jones Industrial Average (INDEX: ^DJI) costs.

But calling NVIDIA overpriced based on P/E alone glosses over some pretty crucial caveats, such as the fact that NVIDIA boasts $2.45 billion net cash on its balance sheet. Back that out of the calculation and NVIDIA costs just over 116036 times earnings, ex-cash.

Or the fact that NVIDIA has been growing both cash profits and GAAP earnings at a steady clip. Free cash flow for the past 12 months stand at $803 million -- nearly 50% ahead of reported net income.

Or the fact that if you first back NVIDIA's cash in the bank, and then value the stock on free cash, you wind up with an enterprise value-to-free cash flow ratio on the stock of less than eight!

Foolish takeaway
Call me an optimist, call me a Fool -- but when I see a stock trading for eight times free cash flow, and expected to grow at a rate nearly twice as fast as that -- 15% -- my first reaction isn't to downgrade it, but to buy the stock.

My second to buy even more.

Much as Fools love NVIDIA, there is on telecom equipment stock we like even more. Read all about it in the Fool's new -- and free! -- report:The Motley Fool's Top Stock for 2011.

At the time thisarticle was published Fool contributorRich Smithowns shares of Google and SanDisk.You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 320 out of more than 180,000 members. The Motley Foolhas adisclosure policy.The Motley Fool owns shares of TriQuint Semiconductor, Apple, and Google.Motley Fool newsletter serviceshave recommended buying shares of Google, Apple, and NVIDIA; writing puts in NVIDIA; and 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.

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