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." While the pinstripe-and-wingtip crowd is entitled to its opinions, we've got some pretty sharp stock pickers down here on Main Street, too. (And we're not always impressed with how Wall Street does its job.)

Given this, 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.

Groupon = Pandora?
Since coming public back in July, Internet radio sensation Pandora (NYS: P) has managed to underperform the Dow Jones Industrial Average (INDEX: ^DJI) by a whopping 15 percentage points -- hardly the result early enthusiasts were looking for. Yet despite the trend's clear downward trajectory, analysts have had pretty schizophrenic reactions to the stock. Those who helped underwrite the offering love it. Those who didn't, don't. So in one sense, I'd say the prospects for fellow 2011 IPO Groupon (NAS: GRPN) look a whole lot brighter than they did (and still do) for Pandora: Even folks who have no dog in this fight have a lot of love for Groupon.

Groupon is less than a week old on the stock exchanges, you see. But already, the rave reviews are rolling in. And here's the surprising thing: Morgan Stanley, Goldman Sachs, Deutsche Bank, JPMorgan -- the list of bankers that helped underwrite this offering seems to include almost every name-brand bank on Wall Street. But the first buy rating to emerge in support of Groupon came from none of the above. It came from Benchmark Capital.

Initiating coverage yesterday, Benchmark argued strongly in favor of Groupon as the "dominant" player in marketing of local and daily deals. Predicting "exponential growth" and "high profit creation" at the company, Benchmark predicts the stock will gain 23% over the course of the next 12 months -- and yes, that's on top of the one-day, 31% profit that early stock owners managed to snag.

Big numbers, big profits?
If even those numbers don't impress you, then get a load of some of the other predictions Benchmark is making. According to the analyst, Groupon is set to:

  • Have "gross billings growth of 450%" in 2011.

  • Collect $1.6 billion in revenue.

  • And then proceed to grow revenue a further 56% in 2012, and 23% more in 2013.

Now, cynics will certainly point out that no matter how much Groupon records as revenues, and no matter how fast the company grows these revenues, the company still continues to trip over one line-item: net profits. And it's true. Since starting business in 2008, Groupon has earned not a red cent of profits -- but it's certainly racked up a lot of red ink. Last year, the company reported GAAP losses of $390 million, a loss that has expanded in the trailing-12-month period to a whopping $528 million.

When you take this history of losing money on its business, and add in the threat of increased competition from the likes of Yahoo! (NAS: YHOO) , Google (NAS: GOOG) , (NAS: AMZN) , Amazon investment LivingSocial, and the host of other "me, too" daily deals sites, things don't look too good for Groupon.

The devil's in the details
Truth be told, I'm a wee bit skeptical myself. But if I might play devil's advocate for just a moment, consider this: If you look beyond Groupon's GAAP losses, page past the income statement, and examine the cash flow statement, then on a trailing-12-month basis, you'll see that free cash flow at Groupon amounted to a not-insignificant $143 million. That's real, cash-in-the-bank inflow, folks, which if you ask me, is even more important than the GAAP "accounting profits" that most analysts focus on.

Granted, this still makes for a pretty rich valuation on the stock -- about 56 times FCF at today's $8 billion market cap. Granted, too, Groupon must expand its profit margins, shore up its revenue growth rate, and grow profits much faster than the 23% pace Benchmark projects for it in 2013, if it's to justify this stock price. But it's not out of the realm of possibility that Groupon succeeds.

Foolish final thought
No beating around the bush here: I'm not optimistic about Groupon. I won't buy it at this price. I probably won't buy it at any price, unless I see some serious improvement. Because even if Groupon does everything I hope it will do, that would still only give me a "fair" price on the stock, and I'm not looking for fair. I'm looking for a steal of a deal, which Groupon stock currently is not.

That said, when an analyst of Benchmark's caliber (Benchmark is ranked in the top 2% of investors we track on CAPS, by the way. Did I not mention that?) tells us there's more to Groupon's story than meets the eye -- it behooves every investor to take a closer look. I may not be buying Groupon today, but I will keep a close eye on the stock.

And if I see a chance to buy it on the cheap, you'll be first to know.

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At the time thisarticle was published Fool contributor Rich Smith owns shares of Google. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 338 out of more than 180,000 members. The Motley Fool has a disclosure policy.The Motley Fool owns shares of Google and Yahoo. Motley Fool newsletter services have recommended buying shares of Google, Yahoo!, and 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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