Surprising Low-Rated Stocks the 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 13% 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 75,000 professional and novice investors alike have rated more than 5,200 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 more. 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 90% 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:

Company

CAPS Rating

1-Year Return

CAPS All-Star

Player Rating

Toll Brothers (NYSE: TOL  )

*

(32.5%)

Gedunken

97.21

Merrill Lynch (NYSE: MER  )

*

(39.7%)

Vavoom11

99.86

TravelZoo (Nasdaq: TZOO  )

*

(51.8%)

stockgripes

95.35

Centex (NYSE: CTX  )

*

(61.5%)

TheDeadCatBounce

98.72

Beazer Homes (NYSE: BZH  )

*

(78.7%)

strutzma

97.87

Typically, when I make these lists, I'll find a low-rated stock that's also enjoyed a large one-year run-up in its stock price. That usually leaves me leery of considering it as a possible investment. Not that stocks can't continue to run, but their high valuations -- even with their low ratings -- leave me a little cold. But that's not so this week, as all of the stocks are posting year-long losses that seem to warrant the low opinion most CAPS investors have of them.

Perhaps more surprising is that homebuilders are starting to get at least a little bit of love. The woes of the housing, mortgage, and credit industries have taken these sectors dramatically down from their previous highs, but it looks like some CAPS All-Stars may be thinking that the worst is over and that all the negative news is already priced into the stocks.

With John Thain now heading up Merrill Lynch, many investors think he can turn the subprime mortgage mess around the same way he turned around NYSE Euronext (NYSE: NYX  ) . Those mortgage woes have only intensified lately, as witnessed by Moody's (NYSE: MCO  ) cutting some 14 classes of Merrill's Alt-A loans because of questions surrounding the underlying assets. Yet CAPS players like Xajorkith think the worst is behind Merrill.

The majority of the blood letting is behind us and the psychological boost of the management change will help Merrill get back in the groove. I expect some more sub prime write downs in the next two quarters but foreign growth should more than offset any additional losses.

Another CAPS All-Star, optionwinners, with a 98.62 player rating, believed earlier this month that finding the right CEO was critical for the company.

This company has been sold off due to the write-offs and the loss of a CEO. There is going to be a new CEO announced soon and that is going to drive these shares on a recovery. This company has sold off so much and is a great broker. If it gets any cheaper there are going to be some significant opportunity for big investors to take a buyout look at the company.

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.


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