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 best...
When one of the best analysts in the world suddenly tells me to sell a stock it had previously recommended buying, I listen. From what I hear, Argus Research thinks it's time to hang up on L-3 Communications
Perhaps the stock's poor performance prompted Argus's change of heart. Over the last three months, L-3 shares have lagged the S&P's performance by nearly 10 percentage points. But it seems the straw that broke optimism's back was recent news of a federal investigation into alleged improper conduct at L-3's Special Support Programs Division (SSPD).
According to a report from Reuters, SSPD was concerned that certain employees might be sharing confidential information with competitors; Lockheed Martin
That's a "no-no"
One analyst called this a "complete breakdown of ethical standards at L-3." The Air Force characterized the actions as "criminal offenses in connection with obtaining, attempting to obtain or performing a public contract or subcontract" and as "theft." And it seems Argus views it as a very good reason to sell the stock. Is the analyst right?
Let's go to the tape
Already ranked in the top 10% of investors we track on CAPS, Argus has a special proficiency in picking aerospace and defense stocks. Of the half-dozen picks it has made in the sector over the past 18 months, only one is underperforming the market today (Lockheed.) Every other recommendation it has made, however, is beating the market soundly:
(NYSE: BA)-- beating the market by 6 percentage points
(NYSE: COL), by 13 points
(NYSE: GD), up 23 points
(NYSE: AER)-- up 315 points!
That said, it's worth pointing out that so far, Argus has racked up all of its gains on the "outperform" side of the ratings. L-3 is the only underperform recommendation it has made in the industry in more than a year. Is Argus overreacting to L-3's bad news?
L-3 by the numbers
Other analysts aren't nearly so pessimistic as Argus. Reviewing the same press releases that spooked Argus last week, JPMorgan conceded that the news increases the risk that L-3 will lose the contract it's been contesting with Lockheed. However, a third analyst, Jefferies, reminds us that SSPD represents only a small portion of L-3's overall business. At worst, Jefferies sees this brouhaha endangering perhaps 3% of L-3's annual revenue, along with $0.15 per share of net income annually, or only about 2%.
When you consider that L-3 shares currently trade near industry-low valuations -- 10.4 times earnings, and just 9.2-times free cash flow -- a 2% handicap seems unlikely to knock these shares out of "value territory" all on its own. So it seems to me that the truly actual question here is whether the SSPD scandal will spin out of control.
Will SSPD's suspension on bidding cost L-3 other government contracts? Will the suspension be applied to other units of L-3? And worst of all, could the Air Force's use of words like "theft" and "criminal" lead to an indictment of the company itself?
A Foolish guess
I don't think so. "Criminal" and "theft" are scary words, but the situation L-3 faces today seems like a 1998 debacle at Boeing, when that company was accused of stealing documents from rival Lockheed Martin to assist in bidding on a rocket-launcher contract. That scandal sounded equally scary at the time; it did ultimately cost Boeing several lost contracts, and a ban on bidding on others. But it wasn't enough to kill the company, or even lock Boeing out of the rocket business. (To the contrary, Boeing ultimately formed a duopoly with Lockheed, in the form of the United Launch Alliance.)
General Dynamics is a Motley Fool Inside Value recommendation, but Fool contributor Rich Smith has no position in any of the stocks named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 495 out of more than 165,000 members. The Motley Fool has a disclosure policy.