This Just In: Upgrades and Downgrades

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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'll be tracking the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

And speaking of the best ...
Collins Stewart initiated coverage of Lockheed Martin (NYSE: LMT) at "buy" yesterday. I wouldn't ordinarily term this banker "best," but its recommendation nonetheless merits mention -- as you'll soon see.

Collins Stewart (CS) recommends that you buy Lockheed because, basically, it's a relative deal. Having successfully beaten out Boeing (NYSE: BA) in the competition to build the Joint Strike Fighter, Lockheed should reap revenue from this program that will keep it growing "even with flat to declining defense budgets," according to the analyst. This should help Lockheed produce "mid-single digit top-line growth and low double digit bottom line growth," rates that CS believes will "compare favorably to our expectation for modest growth from the [rest of the stock] market."

In other words, this is a straight over-under call. Whether or not Lockheed stock is a good deal in its own right, CS thinks it's a better deal than the rest of the market. Fair enough. But just how deftly has CS placed similar bets?

Let's go to the tape
Lately, not so well. Many of its recent recommendations are under-performing the S&P 500. Notable laggards include:

Company	CS says	CAPS says	CS's Pick Lagging S&P By
Digital River (Nasdaq: DRIV)	Underperform	***	35 points
Time Warner (NYSE: TWX)	Outperform	**	12 points

Owing largely to this string of recent bad luck, CS now sports one of CAPS' more miserable accuracy ratings: 44%. But here's the thing -- CS really isn't as bad as it looks, or at least not always. For example, the past month may not have been kind to the analyst, but over the course of the two years we've been tracking it, CS has outperformed the market by an average of over three points per pick, in no small part because of its choices in ...

... the defense industry
Collins Stewart may not have the lengthiest record in defense stocks, but what it does have looks pretty good. Prior to Lockheed, CS had picked several companies operating in the defense sphere. And how are those faring?

Company	CS says	CAPS says	CS's Pick Beating S&P By
Tyco Electronics (NYSE: TEL)	Underperform	***	18 points
GeoEye (Nasdaq: GEOY)	Outperform	*****	15 points
Harris Corp (NYSE: HRS)	Outperform	****	12 points
Force Protection	Outperform	***	117 points

Not bad at all, especially on Force Protection. Maybe even good enough to convince me to overlook an overall record that's substantially less fine-looking than in defense -- at least where this week's Lockheed rec is concerned.

And speaking of Lockheed, I also like the analyst's emphasis on the company's "free cash flow generation." CS highlights this as a factor that can be used to accelerate share repurchases, which would in turn boost per-share earnings at Lockheed. It also, incidentally, provides additional evidence of the stock's undervaluation.

Consider: In normal markets, big, moderately-growing, profitable defense contractors tend to hover around a valuation of 1 times annual sales. Yet Lockheed's selling for 0.7 times sales. That's prima facie cheap, but it's just one metric for determining a stock's proper valuation -- so let's look at a couple of others.

The stock trades for 10 times trailing earnings, yet analysts on average expect the company to grow its profits at 11.5% per year over the next half-decade. And, if we turn to CS's favored metric (and my own) we find Lockheed selling for less than 9 times enterprise vale to free cash flow. If it can grow its free cash flow as fast as analysts think it will grow its accounting profits, the stock could be even cheaper than it first appears.

Foolish takeaway
So, to sum up, Lockheed's got a low P/E, an even lower EV/FCF, and a P/S right down there in the basement with 'em. Put it all together, and I'd say Collins Stewart has found itself a contractor with an eminently defensible valuation, here.