Wall Street vs. Main Street: Does This Upgrade Make Sense?

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." (Indeed, that's all in a day's work over at our column cousin, "This Just In.") For the next few weeks, though, we're going to try to do something special ...

In "Wall Street vs. Main Street," we plan to hold Wall Street's ratings up to a Main Street microscope, point out the bright points and the flaws alike -- and let you tell us whether you think Wall Street's advice holds water. As always, we'll be making liberal use of Motley Fool CAPS in this endeavor, analyzing analyst scorecards and holding them accountable for their records, lifting them up for approval when they deserve it, and holding their feet to the fire when they don't. Onward.

Citi pulls the trigger on General Dynamics
For our first contestant in this contest, we want to aim high, and there's no one higher up there, profile-wise, than megabanker Citigroup. The analyst put itself on our radar just yesterday with a curiously timed recommendation of General Dynamics (NYSE: GD).

As you've probably heard by now, General D got slapped around earlier this week when the Pentagon announced budget cuts calling for the cancellation of GD's $15.5 billion Marine Expeditionary Fighting Vehicle program. Never mind that, says Citi. The real story here isn't General D's military-industrial complex, but its marquee Gulfstream business jets business. Predicting the business jet segment will "show improvement" this year, Citi promoted the General to a "buy" rating and pinned a $87 price target on its chest.

But does Citi's suggestion make sense?

Let's go to the tape
Initial indications look good. Whatever you may think about Citigroup, the bank, and the role it played in creating the Biggest Banking Boondoggle in History, the equity research department at Citi is simply above reproach. Over the four years we've been tracking its performance, Citi has outperformed the market by an average of more than five percentage points per pick, racking up a record of 53% accuracy on its recommendations. Citi's done particularly well in the aerospace arena, where a startling 71% of the banker's best ideas are outperforming the market:

Unfortunately, of the two aerospace stocks Citi has historically misread, one is General Dynamics itself (picked in April 2009 for a 15-point loss). The other is one of GD's key rivals in the business jets world -- Brazilian jetmaker Embraer (NYSE: ERJ). (You may recall this latter name as recipient of a ballyhooed $1 billion, 125-plane order from Berkshire Hathaway (NYSE: BRK-B) last fall.)

Sharp lookin' plane, but ... does it fly?
If Citi's performance on business jets seems less than encouraging, it's not the only cause for worry. I mean ... does Citigroup even read the newspaper? Just this past Monday, the Wall Street Journal took a look at the same b-jets business that Citi says holds so much promise -- but came to the opposite conclusion. Noting that business jet deliveries dropped 42% industrywide over the past two years, the Journal agreed with Citi that they're bound to rebound in 2011 ... but only partway. According to the Journal, even if we look out two years, b-jet builders are still likely to be selling 26% fewer planes in 2012 than they did in 2008.

In particular, the Journal points to the extraordinarily large number of new-model "used" jets left over from the halcyon days of the last business boom. Such "new-to-me" jets pose the greatest threat of stealing sales from actually new planes, and make up a large proportion of the 15% of jets currently available for sale. Put it all together, and the Journal worries that, far from seeing the immediate rebound Citi that promises, we could see a replay of the 1981-1983 collapse, when it took the industry 16 years to return to return to 1981 sales levels.

Foolish takeaway
So, this is where I tell you to toss Citi's advice outta the plane, sans parachute, right? Well, not so fast. While I question the timing (and logic) of the analyst's bull-thesis on b-jets, I'm actually pretty optimistic about General Dynamics as a whole -- because to my Foolish eye, the stock price already incorporates the risk of a slow recovery in Gulfstream sales, and it leaves room for considerable price improvement in the stock if things play out better than feared.

Consider: With $3 billion in trailing free cash flow (which is 20% ahead of reported "GAAP" earnings by the way), General Dynamics currently sells for barely 9 times cash profits. That's cheap even if the pessimists are right, and the General fails to march farther than 7.5% annual profits growth they project for the next five years. Toss in the General's generous 2.3% dividend, and I think the stock looks to be quite the bargain.

How cheap is GD? Last month I explained how an analysis of recent private equity and corporate transactions suggests that any halfway decent member of the military-industrial complex should fetch a price-to-sales ratio of 1.0 -- minimum. If that's the way things play out, General Dynamics stock should rise about 17% from today's prices -- which is almost precisely the price target Citi assigned the stock yesterday.

Now, is this just a happy coincidence of Main Street Foolishness intersecting with Wall Street Wisdom? Or do you think I'm just as dead wrong about General Dynamics as Citi is? Cast your votes on Motley Fool CAPS now -- and see if you can outperform the analyst on this one.