Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

Illinois Tool Works (NYSE:ITW) stock has lagged all year. Down 4% in a market that's gained more than 13%, the shares have shed $30 in price since 2018 began. Yesterday, Illinois Tool Works suffered its biggest one-day drop in nearly seven years after reporting an earnings miss and weak guidance.

Now Citigroup says you should buy it. Here's what you need to know.

Red arrow crashing through a floor

Illinois Tool Works stock just suffered its biggest drop in nearly a decade. So should you buy or sell? Image source: Getty Images.

What Illinois Tool Works said

Reporting earnings for fiscal Q2 2018, Illinois Tool Works told investors it earned $1.97 per share on revenue of $3.83 billion. Sales at this diversified manufacturer were up 7% year over year and earnings climbed 17%, but both fell just short of analysts' estimates.

Despite the miss, CEO E. Scott Santi characterized the company's results as "another strong quarter with good growth momentum and excellent operational execution," highlighting improvements in operating profit margin and a strong 38% surge in the production of free cash flow. Investors, however, had a different take on the report.

Looking past the strong Q2 results, investors appear to have keyed in on a projected "$0.12 negative currency impact versus prior guidance," which reduced ITW's guidance for full-year earnings to a range of $7.50 to $7.70 per share.

What Citigroup said about that

That's not quite the 17% earnings growth that Illinois Tool Works reported for Q2, but it's still a strong 15% earnings growth rate being expected this year. Additionally, management is promising that free cash flow will be "at or above 100 percent of net income" this year, giving the company plenty of cash with which to "repurchase $1.5 billion of its own shares in 2018."

In Citigroup's view, that's a good use of the company's cash. Citi called Illinois Tool Works' guidance "disappointing" in a note covered on TheFly.com this morning. Regardless, the banker believes that "the fundamental strengths of Illinois Tool Works' 'diversified' portfolio and focused business model is not materially changed." The analyst thinks currency impacts "are a real concern" but shouldn't diminish the company's "durable strengths."

To account for the near-term outlook, Citi is cutting its price target on ITW stock to $166 but reiterating its buy rating and recommending that investors use Monday's sell-off as a chance to buy it on the cheap.

What everyone else is saying

It should be pointed out that this view is not universal on Wall Street. According to TheFly's tally of analyst recommendations, at least two other bankers (Goldman Sachs and Merrill Lynch) have already downgraded Illinois Tool Works to neutral in response to the earnings news. Three other analysts -- RBC Capital, Wells Fargo, and Credit Suisse -- cut their price targets, with Credit Suisse in particular opining that Illinois Tool Works looks to be worth no more than $146 a share today, and RBC not much more optimistic, setting a price target of $150.

What to do now

So what should you do if you own Illinois Tool Works stock? Here's how I look at it.

Over the past 12 months, Illinois Tool Works has reported earnings of $1.9 billion. Free cash flow (calculated using a combination of historical data from S&P Global Market Intelligence plus updated numbers from the company's earnings release) works out to an even more robust $2.3 billion.

Weigh these numbers against its $47.3 billion market cap (adjusted for $5.5 billion in net debt), and the stock is selling for an enterprise value of roughly 27.8 times trailing earnings, and 23 times FCF. Both these valuations look optimistic relative to Illinois Tool Works' promise to grow earnings 15% this year. Weighed against analysts' consensus expectation that the company will grow its profits at only 10% annually over the next five years, and the stock is looking downright expensive.

On balance, I have to side with the (many more) analysts who are voting against Illinois Tool Works. It may have turned in a stronger quarter than it's being given credit for yesterday, but the stock is still much too expensive to buy.

Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.