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.

Did I say "sell"? Oops! I meant "buy"
It's not often you see a banker on Wall Street admit it was 100% wrong about a stock. Then again, it's not every day you see a company, sell-rated on the Street, turn around and report earnings more than twice as good as what analysts expected -- yet that's just what happened at E*Trade Financial (NAS: ETFC) last week.

Reporting $0.22 per share in first-quarter profit, E*Trade blew away Street estimates of $0.09, sending the shares up 6% in a few hours of frenzied trading. Since then, the shares have tacked on an extra 2%, and they don't seem to be looking back -- presenting the analysts at CLSA Capital with a conundrum: Should the banker stick with its "underperform" rating or admit defeat and upgrade E*Trade?

After hemming and hawing a few days, CLSA finally made a decision yesterday: It caved.

Big time
Indeed, CLSA not only gave up the fight but surrendered unconditionally on E*Trade, upgrading the stock all the way from "underperform" to "outperform" -- a 180-degree reversal of opinion.

As well it should. After all, having started the year south of $9, E*Trade shares gained as much as 33% before their pre-earnings pullback. Yet even after this rise, the stock hardly seems expensive. At 18 times earnings, it's priced right in between archrivals Schwab (NAS: SCHW) , at 22 times earnings, and TD Ameritrade (NAS: AMTD) , at 17 times earnings. But whereas its rivals are reporting profit declines of roughly 20% apiece, E*Trade stands alone in the industry in reporting profit growth -- an impressive 38% improvement.

The only rival showing a significantly lower P/E, Interactive Brokers Group (NAS: IBKR) , reported an even worse decline in profit last quarter: -32%.

Valuation matters
Given these companies to choose from, it's clear why CLSA might be rethinking its pessimism about E*Trade, which stands head and shoulders above the rest. But relative valuations aside, is the stock a buy in its own right?


Although a big chunk of those earnings gains came from lower provisions on bad loans and lower taxes, E*Trade's growth spurt could be far from over. The company didn't just outgrow the competition last quarter, after all. According to the consensus of more than a dozen analysts who follow the stock, it's going to outgrow the rest of the industry over the next five years as well, tacking on 22% profit growth annually -- faster than Schwab, Ameritrade, or IB can manage. On an 18 P/E stock, that's not just reason to stop selling E*Trade. CLSA is right: It's a great reason to buy.

In fact, I'm so sure E*Trade is on the right track that I'll go ahead and make a public CAPScall on the stock today. I think E*Trade will outperform not only its competition, but the entire stock market -- the whole darn shooting match -- over the next year, and I'll stake my reputation on it.

Think I'm wrong? Follow along.

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At the time thisarticle was published Fool contributorRich Smithdoes not own shares of, nor is he short, any company mentioned above.He does, however, have public recommendations available on more than 50 separate companies. Check them out on Motley Fool CAPS, where he goes by the handle "TMFDitty" -- and iscurrently ranked No. 349 out of more than 180,000 CAPS members. The Motley Foolhas adisclosure policy.Motley Fool newsletter serviceshave recommended buying shares of Charles Schwab, Interactive Brokers Group, and TD AMERITRADE Holding.We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors.Try any of our Foolish newsletter services free for 30 days.

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