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'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 ...
"Best" may not be quite the right word to describe Cowen & Co. But in a world where stock shops like JPMorgan and Citigroup are flailing around near the 20th percentile of ranked CAPS investors, I'll take advice from 70th-percentiler Cowen over the "wisdom" espoused by its name-brand peers any day of the week. And especially the advice that Cowen gave us yesterday, when it upgraded Northrop Grumman (NYSE:NOC) to "outperform."

Let's go to the tape
Why? Well consider from whom the advice is coming. Perhaps best known for its prescient pick of First Solar (back before it became famous), and a string of biotech victories ...

... Cowen's overall performance as a stock picker looks rather hit-or-miss -- emphasis on "miss." 58% of the time Cowen tells you a stock will rise, or that it will fall, the cussed thing goes and does the opposite. Were it not for such home run hits as the three named above, the analyst would be doing far worse than its current average 2.5%-per-pick outperformance of the S&P 500 suggests.

But here's the thing
In contrast to its scattershot record overall, Cowen has put together an amazing string of success stories in the defense industry:

It seems everything defense-related that Cowen touches, turns to gold. And so when the analyst defied conventional wisdom yesterday, and declared that defense contractor Northrop would outperform the market as well, you know I listened up.

According to Cowen, investors have overestimated the risk that the Obama administration poses to defense contractors generally, and Northrop in particular. Cowen's rationale: U.S. contractors operate in the U.S. (natch), therefore spending government money on weapons programs "helps boost the economy" -- a key Obama objective. And while Cowen admits that a drawdown of troop levels in Iraq poses some risk to overall defense spending, Northrop's exposure to Iraq is "limited" in scope.

Meanwhile, Cowen says Northrop has a "hedged portfolio of ramping tactical aircraft work" to help keep its business booming. My own impression of trends in the defense sector tells me that Cowen is right on target here. In particular, Northrop is fast becoming the dominant player in larger unmanned aerial vehicles, one area of the military that President-elect Obama has stated publicly he intends to support and expand.

In addition to all the above, Northrop offers investors an attractive valuation today, even after the post-upgrade run-up. The stock sells for a P/E of less than 10, despite analyst expectations of long-term growth north of 13%, and as a bonus, Northrop is currently generating free cash flows superior to what it reports as net income under GAAP.

Foolish takeaway
Its spotty record elsewhere notwithstanding, defense is one sector Cowen knows well, and its analysis of Northrop is spot on. When this banker tells you to buy Northrop Grumman, you'd be well advised to listen.

On Jan. 12, 2009, Fool co-founder David Gardner, Jeff Fischer, and their Motley Fool Pro team will accept new subscribers to their real-money portfolio service. Motley Fool Pro is investing $1 million of the Fool's own money in long and short positions in a range of securities, including common stocks, put and call options, and exchange-traded funds (ETFs). They also incorporate proprietary CAPS "community intelligence" data into their research. To learn more about Motley Fool Pro and to receive a private invitation to join, simply enter your email address in the box below.