This Just In: More Upgrades and Downgrades

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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." The pinstripe-and-wingtip crowd is entitled to its opinions, but we have some pretty sharp stock pickers down here on Main Street, too. And we're not always impressed with how Wall Street does its job.

So perhaps we shouldn't be giving virtual ink to "news" of analyst upgrades and downgrades. And we wouldn't -- if that were all we were doing. Fortunately, in "This Just In," we don't simply tell you what the analysts said. We 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.

Embraer flying high
As the trading week ends on a happy note, shareholders of Brazilian plane maker Embraer (NYS: ERJ) are smiling wider than most. The reason: German megabanker Deutsche Bank has just initiated coverage of their stock -- and they like it. A lot.

Here's how StreetInsider.com just described the DB endorsement: "With 75% of sales to the commercial aerospace OE markets, Embraer appears well positioned to benefit from the growth in production we see over the next several years. We are forecasting sales to grow at 10% CAGR and EPS +20% CAGR through 2014." To put this in context, current consensus estimates call for Embraer to grow at not 20%, but just 13% per year over the next five years.

That's just about what you'd expect Embraer to produce based on the 12 P/E investors are currently paying for the stock. But if Deutsche Bank is right, the stock could be worth a whole lot more than it's currently selling for. In Deutsche's view, what we're looking at here is a stock worth $38 a share, that only costs $28 a share -- and a chance for investors to snag a 36% profit.

I agree.

Let's go the tape
Let me be totally upfront about this, Fools: I own Embraer stock, so I'm probably inclined to agree with anything positive that an analyst has to say about it. That said, if I had my choice of analysts to fall in love with this stock, Deutsche Bank would be at the top of the list. Why? Because quite simply, Deutsche is one of the best pickers of aerospace stocks out there, as proven by its record in the industry:

Company

Deutsche Rating

CAPS Rating
(out of 5)

Deutsche's Picks Beating S&P by

Honeywell (NYS: HON) Outperform****28 points
BE Aerospace (NAS: BEAV) Outperform****29 points
Goodrich (NYS: GR) Outperform***86 points (picked twice)

Source: Motley Fool CAPS.

Not to put too fine a point on it, but since beginning to report ratings in the aerospace industry four years ago, Deutsche Bank has racked up an enviable record of 80% accuracy on its recommendations. Its average recommendation has outperformed the Dow Jones Industrial Average's (INDEX: ^DJI) returns handily and has simply crushed the S&P 500, outperforming by an average of 21.5 percentage points per pick.

And yes, I believe Deutsche is right again with today's Embraer pick.

Embraer: Buy the numbers
According to Deutsche, Embraer is going to grow nearly twice as fast as most investors expect it to. It will do this, says the analyst, by taking "increased volumes" from its "business jet and commercial aviation divisions," and parlaying the advantages of scaled production into about a 25% gross margin on new planes. For comparison, that's about 5 percentage points better than the gross margins Embraer currently earns -- and it's 6 percentage points better than Boeing (NYS: BA) , and more than 10 percentage points better than EADS.

If Deutsche's right about these numbers, I can easily see the stock rising as high as the analyst thinks. But if truth be told, I think Embraer is a buy even if Deutsche's wrong about the growth rate.

Why do I say that? Well, look at the numbers: Right now, Embraer is selling for 12 times GAAP earnings. Free cash flow at the company is almost perfectly aligned with reported income ($484 million), so we know that earnings quality is high. And Embraer has a clean balance sheet, in which $1.9 billion in debt is balanced by $1.9 billion in cash -- so zero net debt.

Foolish takeaway
At a 12 P/E with 13% earnings growth, Embraer as at least modestly undervalued today -- 15% profit potential, give or take. But if Deutsche Bank sees an opportunity for twice that profit, and if Deutsche's record proves it four times more likely to be right than wrong about these kinds of stocks, who am I to argue?

Are you looking to diversify your aerospace portfolio in an uncertain economy? Read the Fool's new -- and free! -- industry report: "Too Small to Fail: Two Small Caps the Government Won't Let Go Broke."

At the time this article was published Motley Fool newsletter serviceshave recommended buying shares of Embraer, and Fool contributorRich Smithowns shares of Embraer. You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 295 out of more than 180,000 members.We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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