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

And speaking of the best…
With "combat operations" officially ending in Iraq today, and mere months remaining before U.S. troops will (supposedly) start pulling out of Afghanistan, is there any reason to own defense stocks anymore?

For one thing, these stocks are seriously cheap. So says ace stockpicker Wells Fargo, which told investors  this week that now's the time to buy Raytheon (NYSE: RTN) -- one of the cheapest defense stocks on the planet.

Yesterday, Wells took Lockheed Martin (NYSE: LMT) down a notch to "market perform," on fears that pension costs will eat away at the firm's reported profits. The banker sees similar risk in Raytheon -- indeed, Wells predicts that pension expenses will cut into earnings in the sector, and cause earnings estimates to drop industrywide. The analyst singled out Boeing (NYSE: BA) and Precision Castparts (NYSE: PCP), United Technologies (NYSE: UTX), General Dynamics (NYSE: GD), and Northrop Grumman (NYSE: NOC).

But while the risk is real, this banker believes valuations today "already reflect a further 15% to 20% decline in profitability in 2012 and 2013." Wells believes Raytheon offers investors a particularly good value today at just 8.8 times projected 2011 earnings -- and I agree.

Let's go to the tape
I don't usually take defense-investing advice from Wells Fargo. Simply put, the analyst has never had much luck picking stocks in the defense space. Over the four years we've been tracking its performance, fewer than 36% of Wells's aerospace and defense picks have managed to outperform the S&P 500:

Then again, this lack of luck isn't entirely Wells' fault. Things have been tough for some time, for defense investors of all stripes, as we struggle to come to terms with the Defense Department's changing priorities, shrinking wallet, and rapidly closing checkbook.

But while Wall Street may not agree with us yet that defense stocks in general make for good investments, there's really no arguing that Raytheon in particular is anything less than a screaming bargain today. Selling for just 10.6 times trailing earnings and 8.4 times Raytheon's projected 2011 numbers, even Wells's warning about a pension shortfall doesn't worry me overmuch. The analyst may have dropped its 2011 estimate by a quarter to $4.95 per share, but even this pessimistic projection would still leave the stock selling for a mere 8.8 times forward earnings.

Foolish final thought
Here's what really seals the deal for me, even compared to my own favorite long-term defense pick, Lockheed Martin. Right now, Raytheon is proving itself significantly more skilled than Lockheed at converting GAAP "accounting profits" into honest-to-goodness free cash flow.

Over the past 12 months, Raytheon generated a whopping $2.2 billion worth of cash, 31% more than what the company reports as its "net income" under GAAP. (In contrast, Lockheed's $2.9 billion in free cash flow falls somewhat short of reported GAAP profits.)

By picking Raytheon over Lockheed -- at least in the short term -- I believe Wells Fargo has found us a real winner. With a generous 3.4% dividend payout, long-term growth prospects in the upper single digits, and a bargain basement valuation of 7.5 times free cash flow, Raytheon's got all the fuel it needs to rocket your portfolio to the top.