This Just In: Upgrade or Downgrade

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.

Let the bandwagon-jumping begin
Hope you've got your earplugs handy, Fools, because the chorus of "Me, toos!" is starting to get deafening. Last week, as you will recall, the U.S. Army stiffed would-be M-ATV suppliers General Dynamics (NYSE:GD), BAE Systems, and Navistar (NYSE:NAV) -- and instead awarded the billion-dollar armored vehicle contract to Wisconsin-based Oshkosh (NYSE:OSK).

The news set off a chain reaction along Wall Street last week, as analysts scrambled to rearrange their ratings to fit a more complex military-industrial paradigm. General D's bidding partner, Force Protection (NASDAQ:FRPT), got hit with a pair of downgrades, as did its putative chassis supplier, Spartan Motors. On the flip side, Oshkosh received an upgrade from veteran heavy manufacturing analyst Sterne Agee.

Everybody loves a winner
And now come the hangers-on. BMO Capital Markets says the new contract will turbocharge Oshkosh's fiscal 2010 earnings, pushing 'em up to $1.95 per share. And KeyBanc Capital Markets announced Monday that -- surprise, surprise -- it likes Oshkosh, too. Calling the Pentagon contract a "game changer for the Company," KeyBanc sees potentially "$2.3 billion-$2.5 billion" in revenues for Oshkosh, and advises you to buy the stock on its improved "near-term earnings visibility," and the prospects for "cash generation, and debt reduction."

And you know the best part? They may be right. Both bankers boast respectable reputations on CAPS -- the (bare) majority of their picks beat the market, and each outperforms roughly nine out of 10 of their peers rated on CAPS. Not bad ...

On the other hand, consider how they've performed within the "Machinery" sector of the market, to which Oshkosh belongs. KeyBanc maintains a 55% accuracy record on its recent picks here, despite some notable misfires:

While BMO is batting just .444 on a similar assortment of picks ...

... which I have to admit, does give me pause.

I'm also concerned that the analysts may be reading a bit too much into last week's contract win. In particular, KeyBanc's assumption that Oshkosh will earn a "10-12%" operating margin for building the M-ATVs, and thereafter earn a "mid-teen operating margin" on aftermarket revenues, seems a stretch to me.

Why not?
First and foremost, Oshkosh never makes those kinds of profit margins on its work. Go back 10 years, and I challenge you to find a single year in which Oshkosh pulled down a double-digit operating profit margin. It's never happened -- and I don't think it will happen here, either.

Repeat: Why ... not?
OK, a couple more reasons. For one thing, this is a fixed price contract. No chance for Oshkosh to inflate the bill with the kind of "cost overruns" that so often plague Pentagon projects. For another, this is a contract with no room for heel-dragging. The Army wants Oshkosh to build its armored buggies just as quick as it can -- and if it can't, then to farm out the work to subcontractors. In the contest between getting M-ATVs to the front, and booking profits, profits must ride in the rumble seat.

Put all of this together -- the analysts' questionable record in Oshkosh's sector of the market, their perhaps inflated assumptions on profit margin, and so on -- and I very much fear that when Oshkosh finally reports its profits from this deal, Wall Street will be disappointed.

Foolish takeaway
Which brings us to the real danger in yesterday's upgrades. In large part due to analysts' hyperventilating enthusiasm over this high-profile contract, Oshkosh's stock now trades for a pricey 13 times next year's predicted earnings. That's a might high for an expected 10% long-term grower. It would be more expensive still if I'm right, and Oshkosh produces lower margins than predicted.

At which point, investors can only hope Oshkosh's stock is as bulletproof as its armored car.