I think that just about everyone has some form of pet peeve, which is defined as a minor annoyance that an individual identifies as particularly annoying to him or her. Some can't stand when another person chomps their food, or when people are ungrateful, or greedy. Regardless of your pet peeve, or the degree of the annoyance, just about everyone has something that simply gets under their skin.
My pet peeve is and always has been analyst ratings. It drives me crazy, I can't stand it every time a stock reacts to an upgrade or downgrade based on the research of a so called "professional."
The reason I can't stand analyst ratings is because analysts are using the same information that we as investors use but make predictions that are so heavily weighed on the market. I have seen downgrades that cause a stock to fall 15% and upgrades where the stock rises to a similar degree. These calls are nothing more than opinions yet are weighed so heavily in the minds of investors. Some investors will argue that analysts are right much more than the average investor. However, I will argue that I could give a price target for 20 stocks and I will guarantee that at some point over the next year 15 of the stocks will surpass or fall to that particular level. I pay more attention to the downgrade or upgrade, which means that the analyst expects for the company to grow faster or slower, which is what drives the market.
I probably wouldn't care about an analyst opinion if stocks didn't react. But unfortunately that's simply not the case. There is one firm in particular, Bernstein Research, that markets itself as being recognized as Wall Street's premier sell-side firm. The firm downgraded a company on Friday that I believe to be among the most undervalued companies in the market: Alcatel-Lucent (ALU). One of the firm's analysts, Pierre Ferragu, was quoted as saying:
After the networking equipment company generated more than 500 million euros of free cash flow in Q4, the market is no longer worrying about a potential bankruptcy filing. And indeed, the stock through yesterday's close was up 56% year to date. But he adds that going forward, investor focus is likely to shift to the company's financial performance for this year. Ferragu contends that while the company guided for operating margins in 2012 to be above 2011 levels, reaching that goal appears "challenging." He says the company "remains in a stable but challenging position today," and isn't likely to top 4% operating margins.
Luckily, ALU didn't react with a significant loss and is trading near even. But still, the stock had only pulled back after large gains and was poised to trade higher. I find Ferragu's analysis to be incorrect and further challenge how he arrived at such a conclusion. It's difficult for me to understand the $2.67 price target when the company is trading with its best fundamentals in several years. The stock fell off a cliff in 2011, when fear of a European recession spooked the market. ALU lost 75% of its value during the last six months of 2011, despite very few developments to drive the stock lower. However, it has since recovered in 2012 and is trading with a YTD gain of 53% after posting great earnings and its first year of profitability since 2006.
In a previous article I broke down the value being presented within ALU shares to better explain how cheap it's trading. This includes a P/E ratio of 7 and a price/sales of only 0.27, which is among the lowest in the market. In fact, people don't realize that the $5.4 billion company recorded approximately half the revenue of the $106 billion company Cisco (CSCO), and trades in the same industry. Alcatel-Lucent is by far one of the cheapest stocks, according to fundamentals, in the entire market, and with its recent developments I can't validate why a so called "analyst" would give such a particularly low target.
The large YTD gains of ALU are the result of recent developments. Rather than going through each and every development I have included a short summary of the key events that have taken place and the affect that each could have on the company.
- Telefonica (TEF) poised to award ALU with a nationwide high-speed wireless network which shows that European are still upgrading networks to supply the demand despite a troubled economy.
- Alcatel-Lucent is expanding its lightradio, Wi-Fi ecosystem, which will allow smart phones, tablets and other connected devices to move seamless between networks and hotspots.
- ALU will be offering access to its worldwide portfolio of 29,000 patents through a licensing syndicate, which will create more revenue for the company and improve margins.
- Posted 4Q earnings of $0.25 exceeding expectations of $0.07.
- Posted its first full-year of profit in more than five years with improved margins and guidance that margins will continue to improve.
The developments above, among others, have resulted in ALU trading higher by more than 50% in 2012. The stock has pulled back by 8% over the last five trading days but is poised to trade much higher now that investors have taken profits.
To better explain, take a look at the chart below. The stock has been trading higher since January but experienced several periods where it pulled back. Its recent loss hasn't been a straight fall but rather progressive with no discouraging news to entice the loss. Even after today's downgrade the stock traded near flat. This tells me that ALU is poised to trade higher in the coming days and will continue its trend and surpass the $2.63 level that it reached on Feb 24. Therefore, I am giving a little guidance of my own, and upgrading the stock with a target price of $2.75 by March 15, as the uptrend continues and investors buy back shares.
Maybe I shouldn't care so much about analyst upgrades or downgrades. Everyone has a right to their own opinion and an analysts' call is nothing more than an opinion based on the way a firm views a company's fundamentals.
Yet when I read the summary of Bernstein's downgrade I was in utter disbelief. I simply couldn't imagine how the "premier sell-side research firm on Wall Street" could downgrade a company that is trading with a five-year loss of 80% despite trading with its best fundamentals and developments that suggest future growth. Therefore, I decided to perform a search on Bernstein, and simply typed the words "Bernstein cuts" in Google search and the following is the first found results following the downgrade of Alcatel-Lucent, along with the results following the downgrades.
- January 18 2012 - Bernstein cuts Netflix (NFLX) from $79 to $71. Since the downgrade NFLX is trading at $116, and has returned 22% with much better than expected earnings and a new found level of optimism.
- January 4 2012 - Bernstein cuts Salesforce.com, (CRM)from $108 to $89 citing bumpy road ahead; shares fell 5% on the downgrade. Since the downgrade the stock has returned an incredible 42%, with strong earnings, and is now priced at $144.
- February 15 - Bernstein cuts Avon (AVP) from $21 to $20. Despite the stock trading at $18.65, below the target, it has returned a 6.5% gain following strong gains after earnings.
- September 26 - Bernstein cuts Morgan Stanley (MS) from $35 to $30. The stock has since returned 40% despite trading below the target price.
- September 26 - Bernstein cuts Goldman Sachs (GS) to $180 from $205. The stock has since returned 28% but is trading below the firm's target.
I would like to conclude by saying that I am sure Bernstein is a great firm with very educated people. My point to giving these examples, when talking about ALU, is that an analyst call shouldn't be taken too seriously. As I said, I am fairly certain that I could pick 20 stocks and give a target and that it would reach that target price at some point over the next year, and so could anyone. You have a 50/50 chance of correctly choosing the direction of a stock and if your fundamental analysis is somewhat strong then you could probably be a successful analyst. Unfortunately, investors place too much emphasis on these ratings when the reality is that these calls are almost always incorrect.
A $2.67 price target for ALU is laughable, especially if it's based on some form of fundamental analysis. I am certain that Bernstein has been correct on many occasions, but with this particular downgrade I cannot find one reasonable explanation for the target, especially when margins are improving, profits are rising, the company is profitable, and has significant developments to encourage growth. An investment decision shouldn't be determined by what any analyst expects, or on what I say, but with ALU I urge you to do your homework before listening or taking the advice of any firm, even if it's "Wall Street's premier sell-side firm."
Disclosure: I am long ALU.