Thursday's Top Upgrades (and Downgrades)

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Stocks go up, stocks go down -- and so do analysts' opinions of them. This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, we'll be looking at a pair of defense industry plays -- Northrop Grumman (NYS: NOC) and Brazil's Embraer (NYS: ERJ) -- that Wall Street is beginning to warm to, then switch gears and examine a new upgrade for entertainment purveyor Pandora (NYS: P) . Let's dive right in.

Less down on Northr-up
Perhaps the most commonly misspelled name in the investing universe, Northrop Grumman got some good news today, when analysts at investment banker Goldman Sachs announced it was removing its sell rating on the stock.

Goldman had previously advised exiting the equity, based on a "top-down ... very cautious Defense sector view." Quoth the analyst: "We thought the degree of DoD budget reductions would surprise negatively, and that NOC should therefore be avoided as it is one of the purest plays on US platform Defense spending." However, while Goldman's opinion of DoD spending is still "mostly unchanged," it believes that everyone else has come around to its point of view, removing a lot of risk from Northrop, shares of which are down 9% over the past year. Now, says Goldman, is the time to begin positioning for happier surprises -- expanding profit margins and "stronger cash generation" in particular.


And Goldman could be right. Priced at just 7.6 times earnings, Northrop's beefy 3.7% dividend yield is almost enough to justify buying the shares all by itself. Northrop won't have to grow much at all in future years to be worth holding. If the stock drops any more, it just might be worth buying.

Up, up, and away?
If Goldman's warming up to Northrop, though, then analysts at Drexel Hamilton sound downright giddy about the prospects for Northrop's Brazilian rival Embraer. Drexel likes the chances of "increased Brazilian defense projects" boosting Embraer's defense business. Meanwhile, the firm's business jets business is enjoying continued success in markets at home and abroad.

Helping both businesses, Drexel says, are Brazil's plans to cut taxes paid into the local social security system, cuts that could boost Embraer's operating margin by as much as 110 to 120 basis points over the next couple years. That may not sound like much, but for a firm that's only reporting operating profit margins of 4.4% today, it could equate to as much as a 25% bump in per-share profits.

Is that enough to justify a buy rating? Drexel thinks so.

Don't open Pandora's box
Now -- and with apologies for ending on a down note -- we come to the final of our three featured stock picks today: Pandora. The Internet radio company blew away estimates last night, reporting a 93% increase in "listener hours," 53% more "active users," and 58% better revenue than it collected in the year-earlier quarter. That was good enough to win it a $2 bump in target price at analyst JMP Securities, which rates the stock a market outperform and predicts a $16 share price will arrive within one year. But will it?

Read those quotes up again, carefully. What do you see? More hours. More users. More revenue. What word is missing, though?

You guessed it: profits. The one thing Pandora didn't boast about because it couldn't is the fact that it didn't earn any actual money last quarter. To the contrary, Pandora's net loss more than tripled to $20.2 million. (The per-share loss declined due to a greater number of shares being outstanding.) Overlooking this fact, JMP says the stock is a buy, and worth paying more for today, than what the stock cost before Pandora admitted to the larger loss.

Don't you make the same mistake.

Fool contributorRich Smithholds no position in any company mentioned. The Motley Fool owns shares of Northrop Grumman.Motley Fool newsletter serviceshave recommended buying shares of Embraer.

At the time this article was published

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