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 ...
Shares of Intuitive Surgical (NAS: ISRG) surged Monday, ahead of today's hotly anticipated earnings report. That's hardly a surprise. After all, it's been nearly four years now  since the last time Intuitive reported quarterly earnings that looked anything other than brilliant in comparison to what Wall Street was expecting to see. It's also not surprising, given that JPMorgan Chase decided to upgrade the stock.

What may surprise you, though, is why JP upped its opinion of this robotic surgery stock.

Intuitive Surgical: Bucking the odds
You see, according to JP, its recommendation of Intuitive has very little to do with the numbers we're going to see tonight. Fact is, peer medical equipment companies have been warning of weak sales, tied to weaker demand in debt-ridden Europe, for months. Last earnings season saw warnings emanating from companies both large (Johnson & Johnson (NYS: JNJ) ) and small (MAKO Surgical  (NAS: MAKO) ). This time around, we're seeing similar rumblings at companies in the industry such as NuVasive (NAS: NUVA) and Edwards Lifesciences (NYS: EW) -- which is living up to its ticker sound -- "Ewww!"

So it's entirely possible that Intuitive actually will disappoint investors this evening. But according to JP, what Intuitive tells us tonight really doesn't matter, in the larger scheme of things. JP thinks sales and profits will grow substantially for the year as a whole, and again in 2013, as more and more surgeons gain familiarity with, and fondness for, Intuitive's surgical robots. Plus, the banker sees opportunities for Intuitive to expand into new fields of medicine such as gall-bladder and kidney surgery.

All of which has JP extremely optimistic over Intuitive's chances of outperforming the stock market over the long term, and ready to recommend that its clients "overweight" the stock.

Let's go to the tape
This endorsement means a lot coming from an analyst like JPMorgan, which, according to our CAPS records, has outperformed about 92% of investors globally over the past six years and gotten most of its picks right in the process. With a track record like this one, it's likely that many investors will follow JP's lead and buy Intuitive ahead of earnings. Indeed, with the stock's recent run-up, it seems likely that many investors already have taken the analyst's advice. But there's still some risk that they're taking a wrong turn in doing so.

Consider: While JP was an early backer of MAKO, for example, and is still in the green on that one, the banker's also been on record urging investors to buy both NuVasive and Edwards Lifesciences -- and been wrong about both. (Check out the analyst's scorecard here). If this is the way things play out with Intuitive tonight, shareholders could be at risk of taking a serious tumble.

Why? Just check out the valuation of Intuitive Surgical shares. Right now, ahead of the news, Intuitive shares cost a heady 36.5 times earnings. More creative valuation techniques, such as enterprise value-to-free cash flow, suggest the stock's not as overpriced as it looks with an EV/FCF ratio of "only" 28. But that's still a pretty rich price to pay.

Foolish takeaway
Investors willing to pay it are betting that Intuitive will do at least as well as, and hopefully better than, the 20% annual growth rate that analysts expect Intuitive to maintain over the next five years. And yes, that could happen. After all, Intuitive averaged 35% growth over the last five years.

But if earnings warnings from Intuitive's peers are any indication, the days of go-go growth may be at an end. Unless Intuitive both beats earnings tonight, and promisesto keep on beating estimates in the quarters to come, investors may soon discover just how expensive a 36.5 P/E ratio really is.

The recent market sell-off of MAKO Surgical shares has many wondering whether the potential growth prospects of the robotic surgery company make it a buy today or a stock to stay away from. Read our premium report to read up on the details of MAKO's story. Click here to access it now.

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Fool contributor Rich Smith does not own shares of, nor is he short, any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 291 out of more than 180,000 members. The Motley Fool owns shares of Intuitive Surgical, Johnson & Johnson, and MAKO Surgical. Motley Fool newsletter services recommend Intuitive Surgical, Johnson & Johnson, and MAKO Surgical . Try any of our Foolish newsletter services free for 30 days. 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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