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.

Wall Street catches Thai flu
The hits (to market cap) just keep coming. Yesterday, Intel (NAS: INTC) confirmed that the Thai flooding, which idled hard disk drive capacity at Western Digital (NYS: WDC) earlier this year, has indeed depressed demand for semiconductor chips. As result, Intel slashed $1 billion from this quarter's sales projections -- and 5% from its own market cap.

Surprised? You shouldn't have been. In fact, Wall Street's been warning for weeks about the dangers of a "Thai contagion" infecting the computer industry. The logic's simple: If a computer maker like Hewlett-Packard (NYS: HPQ) or Dell (NAS: DELL) can't get hard drives for its PCs, because Western-D and its peers can't supply them, then there's really no sense in building a hard drive-less PC, right? And if you're not building the PC, then it stands to reason you won't be buying chips to install in the PC-that-you're-not-building. (Note to Microsoft (NAS: MSFT) shareholders: You probably also don't need to license a copy of Microsoft Windows for the non-existent PC, either. Word to the wise ...)

As a result, supply chain troubles in hard drives infect demand for computer chips -- and the whole dang PC industry catches the flu.

Paging Dr. Morgan
Indeed, just last week we got confirmation of the epidemic, when Texas Instruments (NYS: TXN) warned shareholders to expect significantly lower sales and earnings in the current quarter, in part because of the situation in Thailand. But there's good news to report as well. Just days after the earnings warning appeared, the tech analysts at Morgan Stanley took a closer look at TI -- and its valuation -- and came to a startling conclusion: The news isn't really as bad as everyone seems to think. In fact, TI just might be cheap enough to buy.

Why? For one thing, Western Digital announced last week that it's already restarting production at one of its formerly flooded factories ahead of schedule -- so while the supply interruption is real, it's also history -- and new inventory is already en route to PC makers looking to get their factories humming again. For another, Morgan Stanley argues that investors fixated on today's headlines may be missing the bigger picture at TI. The analyst argues that:

  • TI is "well-positioned" broaden its revenue streams by as much as an additional "$6B+ in add'l revenue" as it steals market share from rivals,

  • Add further sales into the "smartphone and tablet" markets,

  • And generate "consistent and stable cash flows for investors."

But is Morgan Stanley right? Actually, the numbers seem to argue the opposite.

Valuation matters
Beginning at the beginning, Morgan Stanley argues that TI has the potential to grow its business by something on the order of $6 billion by capturing new revenue streams. This, however, implies about a 50% increase in the firm's trailing revenues. That seems quite a stretch, considering that most analysts on Wall Street think TI will be hard pressed to grow at even a 7.5% annual rate over the next five years.

Nor am I particularly impressed by Morgan's "consistent and stable cash flows" argument. The truth of the matter is that right now, TI's free cash flow lags reported net income by more than 11%. Valued at 12 times "earnings" today, TI's stock looks pricier when valued on its cash profits -- and pricier still when the firm's debt is figured into the calculation. All in, I get an enterprise value-to-free cash flow ratio of 14 on this one -- a number nearly twice as big as the consensus growth rate for TI.

Foolish takeaway
Long story short, the case for buying Texas Instruments looks less compelling than the case for shorting it. While I still like the firm, and agree with Morgan Stanley that it will recover from the Thai troubles eventually, I do not consider the stock a buy at this time.

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At the time thisarticle was published Fool contributor Rich Smith does not own shares of (or short) any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 333 out of more than 180,000 members. The Motley Fool owns shares of Western Digital, Microsoft, and Texas Instruments. The Fool owns shares of and has bought calls on Intel. Motley Fool newsletter services have recommended buying shares of Dell, Intel, and Microsoft; and creating bull call spread positions in Intel and Microsoft. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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