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.

Who's hot, who's not -- in LED stocks
Cree
's announcement earlier this month that it was coming out with a new line of light bulbs to be sold exclusively at Home Depot -- a line of bulbs that would, in many instances, bring the cost of a 10-year bulb down below $10 -- got a lot of people excited up on Wall Street.

The day the announcement came out, Goldman Sachs upped its price target on Cree. A day later, UBS followed suit. Credit Agricole went from bear (underperform) to bull (outperform) in a New York (or perhaps a Parisian) minute.


One analyst, however, remained decidedly unimpressed with Cree's move. Canaccord Genuity, which had already upped its price target on Cree once this year already, held fast with a "hold" recommendation on the stock nonetheless. It's still stuck there, by the way -- but now it seems Canaccord likes nearly everybody else involved in LEDs.

Let the upgrades commence
On Monday, Canaccord announced a series of upgrades in the LED lighting sector. LED equipment maker Aixtron received an upgrade to "hold." Archrival Veeco Instruments got an even bigger vote of confidence, as Canaccord spun on a dime and swung it from "sell" to "buy." Raw materials supplier Rubicon Technology , too, got a new "buy" rating.

But which of these companies is really the best way for an investor to play Cree's move to turn LED lighting a mass consumer phenomenon?

The candidates
I think we can dispose of Home Depot right off the bat. For one thing, at 23 times earnings, the stock's hardly bargain-priced. For another, LED light bulbs make up only a small fraction of the goods on its shelves -- not enough to move the needle much. For a third, Cree's lowering its price point is going to necessitate other LED light bulb makers to follow suit. That means consumers will have the opportunity to buy a lot of cheap light bulbs from makers other than Cree, and at retailers other than Home-D.

On the other hand, the likelihood that we'll see a boom in sales of such light bulbs does suggest there will be more need for equipment to manufacture them -- equipment manufactured by Aixtron and Veeco. So what about those two?

Again, here we're given an easy decision. I think we can write off Aixtron from our shopping list due to the company's current unprofitable status, and the fact that it's burning cash at present. While a bulb-building-boom could improve Aixtron's situation, I'm only interested in investing in companies that I know can earn a profit in lean times as well as fat. Aixtron doesn't pass that test. Might Veeco?

Well, yes. Currently, Veeco is profitable. It's also expected to grow these profits at about 15% annually over the next five years. Free cash flow reporting at the company is spotty, however. While things appear to be going well on this front, the company recently had to delay filing its 10-K with the SEC, and we won't have up-to-date information on the company's cash-profitability until that document comes out. I think the company may have potential -- and Canaccord may be right to recommend it. For the time being, however, I'm going to put a "hold" on the stock myself and wait for more information before making a decision.

The finalists
Whom that leaves us with is just industrial gemologist Rubicon Tech, and Cree itself -- and again, this is an easy choice. Rubicon has been, and remains, a cash-burning operation. Although occasionally considered "profitable" under GAAP accounting standards, the company just doesn't seem capable of generating real cash profits -- and, as such, seems too risky to invest in. Given its history, I have real doubts it will ever become a real contender.

Cree itself, on the other hand, is a stock with some potential -- at the right price. Canaccord hesitates to recommend it, and right now, I'm inclined to agree. The $226 million in free cash flow Cree churned out last year gives the stock an enterprise value-to-free cash flow ratio of roughly 24.4, which seems a bit too high to justify on Cree's projected 18% annual growth rate. But ... if Cree should manage to grow faster than analysts expect, or if its stock should fall victim to one of the occasional bouts of negativity that afflict it from time to time, then Cree could be worth owning.

Long story short, I can't recommend going long Cree today. Not at this price. But as the most attractive option in the field of LED lighting today, Cree's the one stock you want to watch and -- when the right price rolls around again -- buy.

The Motley Fool's chief investment officer has selected his No. 1 stock for the next year. Find out which stock it is in the brand-new free report: "The Motley Fool's Top Stock for 2013." Just click here to access the report and find out the name of this under-the-radar company.

The article This Just In: Upgrades and Downgrades originally appeared on Fool.com.

Fool contributor   Rich Smith   has no positions in the stocks mentioned above.   You can find him on CAPS, publicly pontificating under the handle TMFDitty , where he's currently ranked No. 326 out of more than 180,000 members. The Motley Fool recommends Home Depot. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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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