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." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

And speaking of the best...
When it comes to picking winning stocks, a Fool could do worse than listening to investment banker Bernstein. Ranked in the top 15% of investors we track on CAPS, Bernstein has historically gotten more picks right than wrong over the past few years -- something not every analyst can say for itself.

There is, however, one sector of the stock market in which Bernstein's record has been somewhat less successful: aerospace and defense. Unfortunately for Bernstein, this is the area it's decided to focus on this week, with its downgrade of fighter-jet flying ace Lockheed Martin (NYS: LMT) .

Yesterday, the banker removed its buy recommendation on Lockheed, replacing it with a "market perform" rating, and shaving $4 off its target price. Why? Mainstream media outlets don't seem to have any details on the downgrade just yet, but it's not too hard to guess what's got Bernstein feeling bearish. Over the past few days, we've seen multiple stories come out concerning waning enthusiasm for Lockheed's vaunted F-35 fighter jet, the proverbial "last manned fighter jet" the U.S. Air Force expects will ever get built.

Already, Turkey has cut its jet order in half, while Britain -- the F-35's biggest partner country outside the U.S. -- is also scaling back its commitment. Canada's said to be rethinking its needs, and the Netherlands, too. And just yesterday, Italy joined the hit parade, announcing a 30% reduction in its planned purchase of the plane, to just 90 jets. When combined with U.S. plans to slow down production of the plane for our own needs, this all adds up to higher costs, slower production, and fewer revenues for Lockheed in the near term. But does it add up to a sell thesis for Lockheed?

The bull case for Lockheed Martin
I don't think so, and I'll tell you why. A couple of years back, as part of a Fool survey of the 10 stocks an investor should own when building a portfolio meant to last a decade, I made the argument that investors simply can't afford not to own Lockheed. (I've also put my reputation where my mouth is, publicly endorsing the stock on Motley Fool CAPS.)

The reason is simple: Whatever your opinion of the state of U.S. finances, or those of our allies, there's no doubt the U.S. will need to buy fighter jets in the future. But who is going to build them? Boeing (NYS: BA) , Northrop Grumman (NYS: NOC) , and Lockheed are pretty much your only choices. This is a situation totally dissimilar from most any other industry you can name. Detroit has competition among its various Big Three car builders, from abroad, and from start-ups like Tesla and Fisker. In commercial airplanes, Boeing has Airbus... but also newer rivals in Brazil, Canada, China, Japan, and Russia to worry about. Cellphones, Internet search, retail -- there's competition everywhere.

But when it comes to defense, Lockheed really does have a lock on the fighter jet business. It beat out Boeing for the right to build the stealthy F-35, and barring a major rethink at the Pentagon, it looks like the F-35 is going to be our go-to fighter jet for the next several decades. As a result, its builder -- Lockheed -- is not going away any time soon. It's probably not going away ever.

One reason to worry
So when you get right down to it, I just don't see a delay in F-35 sales as a long-term threat to Lockheed. Ultimately, any country that foresees getting into dogfights at some point in the future is going to want to be on the side that owns the invisible fighter jet. To me, this practically guarantees the fact that the F-35 will sell well in the decades to come.

What does worry me about Lockheed, though, is its competitive position in the field of what-comes-after-the-F-35. Specifically, unmanned aerial vehicles. UAVs. Drones. So far, Lockheed has played second fiddle to most of the major aerospace firms in this field. With its Fire Scout and Global Hawk fleets, Northrop Grumman is far and away the leader here. Boeing has some potential to compete with its new Phantom Ray drone. Textron (NYS: TXT) has its ever popular Shadow. Even Raytheon (NYS: RTN) has made inroads, with its unconventional approach of building the radar-jamming, fighter-jet spoofing MALD rocket.

But Lockheed? Last I heard, it's managed to sell a few tiny Desert Hawk UAVs to the British Army, and anted up a few F-16s for Boeing to retrofit as drones for target practice -- but that's about it. The one big UAV it's succeeded in building so far is best known for having taken an unscheduled pit stop in Tehran.

Foolish takeaway
When I look at Lockheed and see the stock selling for 11 times earnings, but projected to grow these earnings at a healthy 8% over the next five years -- and paying a 4.5% dividend -- I can't help thinking the stock remains a buy. (And I've said as much on CAPS.)

If there was one thing that would get me even more enthusiastic about the stock, though, it would be to see Lockheed develop a credible product in the drone space. Something that could unseat General Atomics as the go-to drone builder, and put Lockheed back in the competition for whatever comes after the F-35. If and when you see that happen, don't wait for me to tell you so -- that will be the moment Lockheed goes from "buy" to "strong buy."

At the time thisarticle was published Fool contributorRich Smithdoes not own shares of any company named above. You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 380 out of more than 180,000 members. The Motley Fool has adisclosure policy.The Motley Fool owns shares of Lockheed Martin, Northrop Grumman, Raytheon, and Textron.Motley Fool newsletter serviceshave recommended buying shares of Tesla Motors.We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors.

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