This Just In: Upgrades and Downgrades

Rich Smith, The Motley Fool
Updated

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.

Welcome back, Goldman Sachs
Christmas came early for investors Wednesday, when Goldman Sachs emerged from a darkened fireplace and unwrapped a whole passel of new Internet stock recommendations. The most (in)famous name in stock picking has just acquired a new Internet guru, and he's wasting no time picking up where the last guy left off. In rapid succession, Goldman announced new buy ratings for:

  • eBay (NAS: EBAY) -- "well positioned to take advantage of the growth in online commerce and payments."

  • Groupon (NAS: GRPN) -- "the Internet's key to unlocking the massive local advertising market."

  • priceline.com (NAS: PCLN) -- "macro concerns, particularly around Europe ... have brought PCLN ... down to an attractive level."

The analyst is less enthusiastic about the prospects for Pandora (NYS: P) , LinkedIn (NAS: LNKD) , and Netflix (NAS: NFLX) (among others). That's not surprising, given that Pandora is profitless, LinkedIn nearly so, and Netflix expects to lose money next year. As a result, Goldman lumped these three in with an additional handful of Internet stocks it feels neither hot nor cold for.

The really interesting rating yesterday, though, was Goldman's recommendation to sell Yahoo! (NAS: YHOO) . It was so interesting, in fact, that it's what we're going to talk about for the whole rest of this column.

Sum of the parts, or some of the parts?
A basket case of a business, analysts have spent the better part of the past two years honing their arguments for why Yahoo! is (or isn't) a bargain based on the value of its constituent parts. The assumption seems to have been that if the company's not worth running as a going concern, maybe it's better to chop it up and sell it off piecemeal to better managed businesses.

Depending on whom you ask, taking Yahoo! to the "equities chopshop" yields perhaps $15 or $16 worth of spare parts -- or basically what the stock's selling for right now. According to Goldman, though, Yahoo! may not be worth even that.

On the one hand, the analyst argues against "any kind of meaningful turnaround" at Yahoo! being unlikely, in light of the company's "competitive and structural headwinds." At the same time, in a wordy rebuttal to Yahoo! enthusiasts, Goldman warns: "While there is significant asset value on the balance sheet and in the company's large, though increasingly less engaged user base, we continue to believe ... that the segment of management driving the company is intent on trying to revive Yahoo as a company, regardless of the cost to shareholders."

Translation: "Unless Yahoo! sells itself, it's doomed, and Yahoo! is never going to sell itself."

Is Goldman right?
About the "never going to sell itself" part? Who knows? I have to believe that eventually, sanity will reassert itself and management will cash out. In which case, shareholders buying at today's prices shouldn't lose too much of their investment.

But as far as Yahoo! not being worth buying unless it sells itself, I wholeheartedly agree. At 18 times earnings, and a projected long-term growth rate of less than 13%, Yahoo! is clearly overvalued on a P/E basis. Worse, the company's promised cash savings from allying with Microsoft never panned out. As a result, Yahoo! is generating way less profit than its income statement lets on -- a mere $585 million over the past 12 months.

Foolish takeaway
The resulting price-to-free-cash-flow ratio of nearly 32 times on Yahoo! seems wildly optimistic to me. When you consider the limited upside of a buyout scenario, the possibility this scenario will never come to fruition, and the vast overvaluation of the stock in the absence of a buyout, I honestly see little reason to own Yahoo! today -- and every reason to sell.

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At the time thisarticle was published Fool contributor Rich Smith does not own shares of, nor is he short, any company mentioned above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 333 out of more than 170,000 members. The Motley Fool has a disclosure policy.The Motley Fool owns shares of Microsoft and Yahoo!. Motley Fool newsletter services have recommended buying shares of Yahoo!, priceline.com, eBay, Netflix, and Microsoft. Motley Fool newsletter services have recommended creating a bull call spread position in Microsoft. Motley Fool newsletter services have recommended writing puts in eBay.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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