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." 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.

Wall Street's leading lights do battle
Investors in LED star Cree (NAS: CREE) lit up last month, when ace tech analyst Goldman Sachs laid out the long-term landscape for the lighting industry. In rapid succession, Goldman named...

  • its winners: Cree in the near term, and OLED pioneer Universal Display (NAS: PANL) farther down the road...

  • and also its losers: Veeco Instruments (NAS: VECO) , and probably by extension, Aixtron (NAS: AIXG) -- both victims of a supply glut in MOCVD LED-manufacturing equipment -- but also cash-burning Rubicon Technology (NAS: RBCN) ...

  • but conspicuously forgot to mention either of the large-cap elephants in the chandelier: General Electric (NYS: GE) and Siemens (NYS: SI) , both of which have such scale of production as to permit them to dominate manufacturing if and when LED demand truly takes off.

Be that as it may, Goldman seemed to prefer Cree, and you might think that the stock becoming some 15% cheaper over the past month would therefore only increase its popularity. I mean, the stock's "on sale," right?

But not so fast, says rival banker Morgan Stanley. There's a reason Cree's shares are slumping, and it's not the kind of reason that makes you want to buy the stock.

Last one out, turn off the lights
In direct opposition to Goldman's buy thesis, Morgan Stanley announced yesterday that it's cancelling its own "overweight" rating on Cree, and dropping the stock down to "equal weight." Why? Because "the company faces risks from industrywide overcapacity, low factory utilization rates, and tough macro conditions."

Seems the massive sales of LED-manufacturing equipment by Veeco and Aixtron (which Goldman noticed) have armed a lot of companies with the manufacturing capacity they need to compete with Cree on price (a fact that Goldman seems to have missed). Morgan further warns that Cree's own purchases of manufacturing equipment have run ahead of LED demand, with the result being that the company has more manufacturing capacity than it can make use of -- hurting profit margins.

And it gets worse. Morgan used to be with Goldman in the bull camp on Cree. However, the bank's analyst note cited that Wall Street's 50% earnings growth estimates "look optimistic" and cut Cree's earnings growth to 37% for next year. Longer term, the consensus on Wall Street is that Cree will fall just shy of 22% annual profits growth (no mention of whether Morgan thought that was optimistic, too).

Foolish takeaway
Admittedly, even "22% growth" probably sounds good to many investors. But it may not be enough to justify the 26 times earnings multiple that Cree currently commands -- the more so when you consider that Cree currently has no free cash flow to back up its claims of "GAAP profit." To the contrary, the company burned through nearly $5 million in cash over the past 12 months.

My guess: Morgan's right to be wary of Cree today.

And my advice? Take Morgan Stanley's advice on Cree. If you're really looking to profit from the LED revolution, stick with undervalued, dividend-rich, free cash flow-positive megacaps like General Electric and Siemens (both of which I've rated outperform on Motley Fool CAPS, by the way. Feel free to drop by and see how they're working out).

Like dividends? Hate overvaluation? Read the Fool's new -- and free! -- report: "13 High-Yielding Stocks to Buy Today."

At the time thisarticle was published

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