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.

And speaking of the best...
Shareholders in robotic surgery specialist Intuitive Surgical (NAS: ISRG) received a late Christmas present in the mail yesterday -- or perhaps you could call it an early "Earnings Day" present. With the company expected to report earnings on Jan. 19, the stock actually received an early bump this week when ThinkEquity decided to initiate coverage of the stock at "buy."

Now, it's probably a stretch to call ThinkEquity "the best" stock-picking team on the Street. While ranked in the top quartile of investors according to our CAPS stats, ThinkEquity relies to a large extent on the underperformance of its peers for its own (relatively) strong ranking. Fact is, most of this analyst's recommendations actually underperform the market, and within the very competitive health-care industry, the banker's outperform picks only manage to beat the market about half of the time.

Between the mixed bag that is TE's record and Intuitive Surgical's own apparent lofty stock price ($472 and change), I have to say that I come to this recommendation with a dose of skepticism. But let's give the stock its due. Let's take a quick look at Intuitive Surgical's numbers, and see if they really do live up to the hype.

Let's go to the tape
Priced at 40 times earnings, Intuitive Surgical isn't what you'd ordinarily call a value stock. Indeed, even if you value Intuitive on forward earnings expectations, the stock's 33 forward P/E looks a bit expensive relative to consensus expectations for 20% annual long-term growth. Other metrics look similarly... optimistic:

  • Price-to-sales ratio: 11.0

  • Price-to-book: 7.8

  • Price-to-free cash flow: 36.3

So as I said, fans of Intuitive Surgical must be pretty enthused about the company's prospects, to be willing to ante up these kinds of prices. They aren't, however, the only investors getting excited about the prospects for medical devices makers. Just earlier this week, for example, the analysts at Summer Street Research issued a buy recommendation on MAKO Surgical (NAS: MAKO) , a similar robotic surgery company that specializes in knee replacement procedures, and that recently received FDA approval to use its RIO system in hip replacement surgery.

Prior to that, we've seen Stephens sing the praises of tiny MELA Sciences (NAS: MELA) , which, like MAKO, had recently become the beneficiary of a positive FDA ruling. And in December, Citigroup named Medtronic (NYS: MDT) its top pick in the whole darn medical devices and technology shooting match.

Great expectations...
What do all these companies have in common? Well, like Intuitive, both MAKO and MELA have great expectations for future growth underlying their stock prices. Predictions for MAKO basically track the 20% growth potential that Wall Street sees in Intuitive. Meanwhile, at MELA the analysts are looking for an astounding 40% annual growth rate over the next five years.

Regardless, in a head-to-head competition I still have to prefer Intuitive over either of these also-rans for the simple fact that while neither MAKO nor MELA are currently profitable (or indeed, generating any free cash flow at all), Intuitive not only earns substantial profits, but generates free cash flow at a rate exceeding the rate at which it reports GAAP earnings.

...and great peril
So why is it that I can't go along with ThinkEquity and endorse Intuitive Surgical myself? The answer's really quite simple: the price. If everything goes swimmingly two Thursdays from now and Intuitive hits the analyst's targets, it doesn't matter whether you value this company on P/E, forward P/E , or P/FCF. Any way you slice it, the stock still costs too much for 20% growth. If, on the other hand, Intuitive slips, and for whatever reason disappoints investors -- whether by reporting too few revenues, or too little profits... or even promising to produce less than expected in coming quarters -- Intuitive's share price would come crashing down.

Call me a coward, or just call me a Fool, but I'd personally be more comfortable owning a stock for which expectations are set low and the potential to exceed these expectations is a bit bigger. This, to me, sums up the situation at Citi's pick: Medtronic.

Here we've got a stock selling for 12 times earnings that, like Intuitive, regularly churns out free cash flow superior to its reported income. Sure, no one's expecting Medtronic to turn in 20% annual growth rates. But by the same token, the sub-7% growth rate it is expected to produce should be much easier to beat. Meanwhile, whatever Medtronic does earnings-wise, the 2.5% dividend checks should keep rolling in.

My advice? Leave the high-growth, high-risk game to the analysts at ThinkEquity. Judging from their record, they've got a 50-50 chance of getting it right, and are happy with those odds. If you want a 100% chance of making at least some money off your investment, though, Medtronic and its 2.5% divvy is likely the stock for you.

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At the time thisarticle was published The Motley Fool owns shares of Medtronic and MAKO Surgical, andMotley Fool newsletter serviceshave recommended buying shares of Intuitive Surgical and MAKO Surgical, but Fool contributor Rich Smithdoes not own shares of any company named above.You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 343 out of more than 180,000 members. The Motley Foolhas adisclosure policy.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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