Surprising Low-Rated Stocks Leaders Love

Piggybacking on the picks of great investors and money managers can often lead to big rewards -- especially when the stocks in question are beaten down.

If you'd bought Ingersoll-Rand when Warren Buffett announced his small stake in this industrial company last February, you'd be enjoying a roughly 25% gain so far. You'd be up another 40% if you'd followed David Dreman of Dreman Value Management into aerospace and industrial products manufacturer Barnes Group at the end of March.

Over on Motley Fool CAPS, more than 65,000 professional and novice investors alike have rated more than 5,000 stocks, indicating whether they think those companies will beat the market or lose to it. The best investors, those who consistently outperform their peers, are considered All-Stars. They might not match Buffett, Lynch, or Dreman yet, but their records are remarkable all the same.

The best of the best
All-Stars each boast a CAPS rating of 80% or higher. That's plenty good, but I wanted to see which companies the very best All-Stars were choosing. I searched CAPS for players with a rating of 95% or better. Then I searched through this set of players to see who'd chosen one- and two-star stocks to outperform the market.

Why low-rated stocks? Just like the players, stocks receive ratings, too, from one to five stars. The majority of CAPS investors may think these stocks are dogs, but our top All-Stars believe they'll have their day. It's a typical contrarian-investor concept -- what value investing legend Benjamin Graham called "picking up cigar butts."

These five one-star stocks have gotten the nod from the cream of our CAPS All-Stars:

When making this list, I usually find a low-rated stock that has had a large one-year run-up in its stock price, which leaves me leery of considering it as a possible investment. Not that stocks can't continue to run, but high valuations combined with low ratings leave me a little cold. This week's big mover is Hoku Scientific, which is up more than 200% for the past year. While investors suffered a slight setback in June when earnings and guidance came in below expectations, it seems too early to tell whether Hoku is still casting about for just the right alternative-energy source to back, or whether it's truly diversifying revenue streams in ethanol, solar, and polysilicon technologies.

Several corny alternatives
It seems a number of alternative-energy stocks have made the list this time. FuelCell Energy and Pacific Ethanol have both gotten the nod from CAPS All-Stars, though their results do not approach the enthusiasm generated by Hoku. While FuelCell has had a hard time stringing together good quarters, Pacific Ethanol has actually been able to make corn-based fuel alternatives and additives a viable business.

CAPS investor scottrenz believes Pacific Ethanol will outperform the market not only because of government mandates, which will certainly drive the market forward, but because of the company's own research and development efforts.

A higher percentage of ethanol will be used in gasoline as an additive over the next few years. Plus more E85 (85% ethanol and 15% gasoline) will be used as a fuel in place of normal gasoline which the government is encouraging to promote energy self reliance and prevent global warming. Also, processes for making cellulosic ethanol are being researched and are about to make a break through where what used to be agricultural waste or unusable plants will be used to make ethanol.

Top-rated research and industry analysts at Netscribes penned the top bullish pitch here, forecasting market demographics pushing this company ahead.

On the operational front, prices of corn could rise further due to its rising usage in producing ethanol, creating supply concerns. However, the use of ethanol as a preferred oxygenate to blend with gasoline would help the company to offset the rising raw material costs. Considering the rising pollution in U.S, the 'Global warming solutions act of California' is emphasizing ... reducing carbon emissions that would encourage the usage of environment friendly ethanol in the coming years. In the light of these facts, the scrip looks set for a big bull run in the near future.

As for our other contenders: While housing has been on the rocks for awhile, is it really ready to rise just yet, or are there more repercussions still to be felt? And Krispy Kreme is a soggy remnant of its former glazed self. It's the one stock in our group this week on which bears outnumber bulls, and All-Stars betting against a turnaround outnumber their counterparts by 3-to-1. It's a hard sell, like day-old doughnuts.

Finding value under rocks
So there you have it: five low-rated laggards that have gotten a big endorsement from some of the best and brightest investors in the CAPS community. What do you have to say? If you want to add your two cents, sign up to join the Motley Fool CAPS community, which is 100% free.