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 ...
Is revolution and insecurity in the Middle East a good thing for defense stocks? Logically, it should be. When people are nervous and seeking security, well ... nothing's more conducive to sound sleep than having a nice big .45 Smith & Wesson sitting on the nightstand.

And yet, a lot of folks are taking the opposite view lately. Turmoil in the top echelons of Middle Eastern governments puts arms purchases in jeopardy, you see. It puts existing defense contracts at risk -- and what's to say the new rulers will sign new contracts? According to the smart stockpickers at RBC Capital Markets, concerns like these are weighing on the defense sector as a whole, and on Raytheon (NYSE: RTN) in particular. With Raytheon shares now selling for a mere "9.3 times 2012 earnings estimates," RBC argues that in an already underpriced defense sector, Raytheon shares are the best bargain out there -- and on Friday, RBC put its reputation where its mouth is, and upgraded the shares to "outperform."

Was that the right call?

Let's go to the tape
According to the analyst, there's a number of reasons to like Raytheon at today's price. "Except for Egypt, the other key purchasers [of Raytheon's weapons] look more secure... The strategic concern over Iran has not gone away, while purchasing countries remain well financed by ... oil."

Bold statements for troubling times, but RBC has the reputation to back them up. Over the four-plus-years that we've been tracking this analyst's performance, RBC has proven itself a savvy picker of winning defense stocks, racking up 56% accuracy on recommendations such as:

What's more, but for one really badly timed recommendation of GD partner Elbit Systems (Nasdaq: ESLT) back in September 2009, these recommendations would have been beating the market soundly, outperforming the S&P 500's performance by a good three-percent margin. That may not sound like much, but it's an impressive feat to outperform at all in an era of Pentagon budget-cutting.

In short, if there's one stockpicker you want to listen to when it comes to picking winning defense stocks, RBC may well be it -- and if there's one defense stock that's likely to outperform the rest, then Raytheon may be it.

Raytheon rising
Why? Well, let's start with the numbers. Right now, a share of Raytheon will set you back about 10.7 times trailing earnings, or 9.3 times next year's estimates. With the average S&P stock costing 13.7 times forward earnings, that's already a pretty sizeable, 22% discount. Raytheon also compares favorably to its defense contracting peers. All of the defense industry players named above sport higher P/E ratios than Raytheon. So too do Boeing (NYSE: BA) and Textron (NYSE: TXT), at trailing P/E ratios of 16.4 and 100 (!) respectively.

But what really sets Raytheon apart from the competition, I suspect, is the very factor that's weighing on the stock today: revolution in the Mideast, and in Egypt in particular. As far as the bear arguments that this is bad for Raytheon's business go, my only reaction is "Seriously? The Army is running Egypt's government now. And you think that when the Army is running things, Egypt will buy fewer weapons systems than before?" Seems to me, whoever came up with that argument has been out in the sun too long. Far from being bad for business, I think the Egyptian revolution could be a stroke of luck for Raytheon.

Raytheon makes its own luck
But if that's so, it's luck of Raytheon's own making. As RBC points out, Raytheon has made a conscious effort to diversify its revenue stream away from strained U.S. (and allied) defense budgets, and toward more affluent customers. Currently, the company derives 23% of its revenue from foreign sales, a proportion larger than any of its defense industry brethren can boast.

So sure, Raytheon naysayers may argue that Mideast turmoil puts these revenue at risk. Personally, however, I believe that Raytheon's making all the right moves to position itself to profit in a multipolar world. RBC says this strategy will generate industry-beating "overall growth ... coupled with higher margins." Far from justifying a discount on the stock, RBC points out that Raytheon's international diversification has historically "justified a premium valuation for Raytheon."

I agree.