This Just In: More 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 worst, we've got some good news this week for Northrop Grumman (NYSE: NOC  ) shareholders: Goldman Sachs no longer rates your stock a "conviction sell."

But it still wants to sell your stock.

Unconvincing analysis
Considering the strength of Northrop's Wednesday morning earnings release, you'd think Goldman might reconsider. Amid a depressing market for defense investors, Northrop grew sales 4%, upped earnings per share 13% (to $1.64 per share), and produced a whopping $817 million in quarterly free cash flow. In the process, it bought back 3 million shares and raised guidance to as high as $7 a share for this year.

Goldman remains unconvinced, insisting the stock is a sell. I disagree.

Let's go to the tape
Let's give credit where credit is due: Goldman has proved truly adept at picking defense stocks. Since we began tracking Goldman's picks in the defense sector a little more than a year ago, it's managed to earn and hold onto a record for 62% accuracy on its recommendations, correctly calling both winners ...

Companies

Goldman Says:

CAPS says

Goldman's Picks Beating S&P By

BE Aerospace (Nasdaq: BEAV  ) Outperform **** 13 points
Precision Castparts (NYSE: PCP  ) Outperform ***** 8 points

... and losers alike:

Companies

Goldman Says:

CAPS says

Goldman's Picks Beating S&P By

L-3 Communications (NYSE: LLL  ) Outperform ***** 22 points
Lockheed Martin (NYSE: LMT  ) Outperform **** 9 points

Despite that fine record, it hasn't taken a real genius to predict that defense stocks would suffer in the current environment of daily defense cuts. Investors are fleeing the sector in terror, and the stocks are suffering in consequence.

However, if you look past the short-term fears, I believe the selling has been overdone. This creates a terrific opportunity for investors to profit in the long term, especially on Northrop Grumman.

Generating free cash flow at the rate of $1.4 billion per year, Northrop sells for the temptingly low price of just 13.2 times free cash flow today. Meanwhile, even baking in expectations of lower defense spending going forward, most analysts still believe Northrop can maintain 11% annual earnings growth for the foreseeable future, and pay investors a strong 3.1% dividend while we wait to see how things play out.

While these numbers don't look as good from this perspective as the stock's headline 9.4 P/E would suggest -- Northrop only looks cheaper than General Dynamics (NYSE: GD  ) and Boeing (NYSE: BA  ) -- they still look plenty good enough to me. Certainly not bad enough to merit a sell rating.

Foolish final thought
If you read through the substance of Goldman's report, it almost sounds like the analyst is having second thoughts of its own. Despite panning Northrop yesterday, the analyst made a point to praise the company for producing solid Q3 results and continuing to improve operations. Goldman even sees a "catalyst" that could drive the stock price higher, when Northrop sells or spins off its shipbuilding operations.

As for why all this adds up to a "sell" rating in Goldman's view ... your guess is as good as mine. I mean, attractive valuation? Check. Getting out of the shipbuilding biz ahead of a defense-spending slowdown? Check. Progress in the other divisions? Check, check, check.

Call me crazy, but none of this adds up to a sell argument for me.

General Dynamics is a Motley Fool Inside Value recommendation and Precision Castparts is a Motley Fool Stock Advisor selection, but Rich Smith does not own shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 578 out of more than 170,000 members. 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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