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." So you might think we'd be the last people to give virtual ink to such "news." And we would be -- if that were all we were doing.

But in "This Just In," we don't simply tell you what the analysts said. We'll also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

And speaking of the best ...
What a difference a few months can make. Four months ago, bad news for Force Protection (NYSE:FRPT) had Wall Street analysts tripping over their wingtips as they dove for cover on previously bullish upgrades of the stock. When Oshkosh (NYSE:OSK) won the M-ATV competition, it removed the last faint hope that Force Protection would become a "force" to contend with in the market for big-ticket armored vehicles.

Now that Force has faced up to reality, refocusing on servicing vehicles and developing hi-tech add-ons for the military's ground fleet, the analysts are starting to emerge from their bunkers. Case in point: Inspired by a not-too-awful third quarter report, FBR Capital voiced cautious optimism about Force Protection yesterday: "we think that the stock will likely trade as high as $8.00 to $9.00 in the near term, given recent strength on certain programs during the quarter, including the Buffalo, Force Armor, and independent suspension kits."

That said, FBR worries about the sustainability of Force's improvements, and accordingly, believes that after spiking to nine bucks, the stock will subside to "our longer-term price target [of] $6.00."

Make up your mind, FBR!
So is Force Protection a buy, or a sell? In FBR's estimation, it's neither -- just a "market performer." But as a Force shareholder myself, I'm compelled to make the following intellectual rejoinder ...

We're rubber, you're glue, what bounces off me sticks to you
You see, when it comes to defense stocks, FBR is a kind of "market performer" itself. While the analyst has made some good calls in its day -- when it panned First Solar (NASDAQ:FSLR) last summer, for example, or when it sounded off on Amazon.com (NASDAQ:AMZN) last month -- out of the 20 recommendations it's made in the Aerospace and Defense sector over the last three years, precisely 50% of FBR's picks have beaten the market ... and 50% lagged it:

Read the fine print
FBR's iffy record notwithstanding and half-hearted endorsement notwithstanding, investors took yesterday's upgrade to heart, bidding up Force Protection shares more than 6%. Now that they've had time to digest the analyst's reservations, however, the shares are trading back in a more southerly direction.

But the real question shouldn't be whether FBR thinks Force will trade at $9 in the short-term or $6 in the long-term -- the real question should be: What's it worth?

For what it's worth ...
Here's how I look at the value equation for Force Protection. As of the end of the third quarter, Force had generated $13.2 million in free cash flow. If things continue accordingly, this puts the company on track for about $17.6 million in free cash flow by year-end. With an enterprise value of just $260 million, this suggests to me that the stock is fairly priced if it can grow its profit at 15% per year over the long term. In fact, however, most analysts predict a 20% growth rate for Force over the next five years -- suggesting the shares are significantly undervalued here at $5 and change. (I'd posit a $7 price as being more appropriate.)

Another way of looking at Force -- yesterday we saw Northrop Grumman shares jump on news of a successful divestiture of its TASC division, which was valued at just over one-times sales. If this means that defense contractors are once again reclaiming their historical valuation standard of "1x sales" as it was during the Bush administration and before the financial crash, then Force could be even cheaper than I've argued above. With about $1 billion in sales over the last 12 months, and a market cap of $370 million (here we're ignoring the firm's sizeable net cash balance), a 1 times valuation on the shares would suggest a "fair" valuation of something closer to $15.

Foolish takeaway
When you get right down to it, investing is always a guessing game -- it's just that some investors are better guessers than others. When deciding whether to buy Force Protection, what you need to ask yourself is, are you a better guesser than FBR?

If you can guess right better than 50% of the time, you are.