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

Given this, 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. But before we get to telling you what they're talking about this week, I need to make a...

Public service announcement
Warning: If you don't like cheap stocks and big potential profits, stop reading right now. Click over to -- I don't know, The Onion maybe. Or Dilbert.com. Or Barron's. You know, something lightweight. Because today's column is for serious investors only, investors who won't be scared away by the fact that we're going to be talking about a deeply unpopular industry: defense stocks.


Does Huntington float your boat?
You see, last week brought us a very good recommendation from the analysts at Drexel Hamilton: Navy shipbuilder Huntington Ingalls (NYS: HII) . Upset at how Huntington's results kept hurting its own numbers, parent company Northrop Grumman tossed Huntington overboard last year. But as Drexel explains (hat tip to StreetInsider.com for the details), Huntington has basically wrapped up its low-margin "problem programs." As a result, profit margins are likely to rise sharply in future years. In fact, Drexel foresees "double-digit earnings growth for the company ... for the next three years" at least.

Compare this to the performance analysts expect to see elsewhere in the defense industry:

Company

P/E Ratio

Price to Free Cash Flow

5-Year Projected Growth Rate

HuntingtonN/A5.610.6%
L-3 Communications7.86.82.1%
Northrop Grumman8.88.05.0%
Lockheed Martin10.739.27.1%
Boeing12.926.410.6%

Source: finviz.com.

As you can see, Huntington is currently unprofitable. Yet the consensus among defense industry analysts is that Huntington will tie Boeing for the highest growth rate in this industry over the next several years.

Meanwhile, Huntington reaps scorn from investors for its unprofitable GAAP numbers, but it boasts the lowest price-to-free-cash-flow ratio in the industry. Or put more simply, while Huntington looks like an expensive stock, it's actually, arguably, the cheapest defense stock on the market today.

Huntington: real stealth technology
Huntington's non-existent GAAP profits have the effect of hiding the stock from a lot of investors who try to screen for value using P/E ratios. But Huntington can't stay hidden forever. According to Drexel Hamilton, the company's rapid margin expansion, from an expected 4% for year-end 2012 to as high as 6.4% in 2015, suggests that in three years Huntington will be earning steady profits in the neighborhood of $5 per share, per year.

This is when Huntington will finally become a visibly cheap stock. At today's stock price, $5 a share would work out to a P/E ratio of about eight -- on par with L-3 and Northrop, but growing at a faster clip.

Drexel's advice to buy Huntington before that happens -- to buy the cheap company while it still looks expensive -- seems sound to me. This is one shipbuilding stock idea that truly does hold water.

(Want another? We've got a million of 'em! Read our new report, and find out about one more defense stock, and three more non-defense stocks, that could skyrocket after the 2012 presidential election.)

The article This Just In: More Upgrades and Downgrades originally appeared on Fool.com.

The Motley Fool owns shares of L-3 Communications Holdings, Northrop Grumman, and Lockheed Martin, but Fool contributor Rich Smith holds no position in any company mentioned. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 276 out of more than 180,000 members. The Fool has a disclosure policy.We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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