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." 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.

Today, most of what Wall Street is talking about is tech stocks, as Pandora (NYS: P) and Zillow (NAS: Z) score upgrades, while fellow Internet "star" Groupon (NAS: GRPN) gets dissed. Let's find out why.

Time to open Pandora's box?
New York-based broker Albert Fried & Co. starts us off today with a new upgrade (to overweight) for Internet radio player Pandora. As points out, even Albert Fried admits that it's never been a huge fan of Pandora, citing worries over corporate governance, valuation, and especially, over Pandora's inability "to grow FCF over time."

For many investors, these concerns remain in full effect. But, according to the analyst, recent worries of competition from the Songza service (founded by the same folks who sold to in 2010) have gotten so blown out of proportion as to create a "buying opportunity" in Pandora despite all the stock's other defects.

Me, I'm not so sure. Songza or no Songza, Pandora remains a deeply unprofitable company. And even if it does earn the profit Wall Street projects next year, the nickel-back of profit this Internet disc jockey is expected to produce would still leave its stock trading at a triple-digit P/E. Call me a skeptic, but I'm not sure that this is a good argument for buying Pandora. It might even be a reason to sell.

How accurate is this "Zestimate"?
A second Internet stock scoring kudos on Wall Street today is virtual house-appraiser Zillow. Pacific Crest upgraded shares of Zillow to "outperform" with a $40 price target on what it sees as great opportunities to "increase agent adoption and monetization." It also believes there's plenty of upside to margins over the next few years, but whether the shares have any chance of following suit is pure speculation.

On one hand, the valuation picture hardly looks attractive. Zillow costs 327 times trailing earnings today, and sells for about 50 times what it's expected to earn next year. On the other hand, if you value the company on its free cash flow, the math looks a little better but doesn't even border on cheap.

Analysts have Zillow pegged for 50% long-term profits growth, and Zillow's on track to meet or exceed that target. Operating cash flow sextupled between 2010 and 2011, and is growing again this year. Meanwhile, capital spending grew less than 60%, showing that Zillow is reaping great benefits of scale from its asset-light business model. At present, the numbers still make no clear case for Zillow being undervalued -- but if it keeps growing at its present rate, I wouldn't bet against 'em.

Is Groupon your daily deal?
For analogous reasons, I'm less than convinced that Ascendiant Capital is right to be cutting price targets at Groupon. This morning, the analyst slashed $3 off its price target for the Internet deals couponier, which Ascendiant now values at just $8 a share -- and recommends selling.

According to Ascendiant, Groupon's "recent restatement and weakness in controls are likely to bolster continued skepticism as to Groupon's valuation, growth prospects, and profit potential." The analyst is further concerned that increased costs of refunding unused Groupon purchases could crimp profits.

But even after conceding all this, a Fool has to admit that Groupon's more-than-50% decline in share price so far this year has squeezed a lot of risk out of the stock. While currently "unprofitable," Groupon is nonetheless generating copious cash flows, with actual free cash surpassing $310 million over the past 12 months.

Foolish takeaway
Now mind you, Groupon still isn't our absolute favorite Internet stock here at the Fool. (To find out what that is, all you need do is click here to download our free report: "Forget Facebook -- Here's the Tech IPO You Should Be Buying.") But at less than 20 times annual free cash production, and with a growth rate estimated at 31% annually for the next five years, Groupon -- dare I say it? -- actually looks cheap.

Whose advice should you take -- mine, or that of "professional" analysts like Albert Fried, Pacific Crest, and Ascendiant?Check out my track record on Motley Fool CAPS, andcompare it to theirs. Decide for yourself whom to believe.

Editor's note: An earlier version of this article incorrectly stated that Songza is a subsidiary of We regret the error.

At the time thisarticle was published Fool contributorRich Smithdoes not own (or short) shares of any company named above. You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 342 out of more than 180,000 members. The Fool has adisclosure policy. The Motley Fool owns shares of Zillow and Fool newsletter serviceshave recommended buying shares of and Zillow. 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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