The Next 5 Stocks to Buy?

Even gold prices at record levels don't always translate into record profits for gold mining companies. They can do more with less for a while as high prices bolster failures, but eventually they'll have to correct their problems.

That's what South African-based DRDGOLD has been doing this year while a series of setbacks held back the company's profits -- and its stock price. It separated its business into two operating units, South Africa and Australasia, and it just announced that it will be laying off hundreds of workers at an underperforming South African mine (ERPM, or East Rand Proprietary Mine) that has been giving it fits. The mine has been subject to a pattern of declining production and rising costs, so a retrenchment there was needed.

DRDGOLD also suffered from problems not of its own making, such as the power outages that have plagued South Africa's electricity grid. Overall production dropped 9% last quarter as a result of power cuts, but the feeling is that if it can work at least at 95% of its power supply, current production levels can be maintained. That will be essential for this improving gold miner. With a narrower focus on its two divisions, a low-debt financial structure, and an unhedged production policy that lets it earn maximum profits from rising gold prices, DRDGOLD will be able to explore replacing its aging South African assets, which at least one analyst has described as "decrepit."

Screening for likability
DRDGOLD, however, showed up on a screen of companies that have enjoyed growing investor support these days after starting the year on the outs. DRDGOLD jumped from a two-star Motley Fool CAPS rating back then to a three-star rating today, while also enjoying a valuation that's lower than that of the overall market.

CAPS is an investor community with 110,000 members who rate thousands of stocks based on whether they will outperform or underperform the market. While it's not a predictive service, in its first year, the trailing returns of the stocks in the CAPS universe correlated precisely with their relative CAPS rating. Four- and five- star stocks outperformed low-rated one- and two-star stocks.

Here are a few of the other companies the CAPS screener found that are enjoying significant support:

Company

CAPS Rating January

CAPS Rating Today

Forward PE

PEG*

Cardiac Science (Nasdaq: CSCX  )

**

****

17.3

1.5

DRDGOLD (Nasdaq: DROOY  )

**

***

   10.7

0.4

Dycom (NYSE: DY  )

**

*****

16

1.3

Pacer International (Nasdaq: PACR  )

**

****

11.2

0.9

Wal-Mart (NYSE: WMT  )

**

***

14.7

1.3

Source: Motley Fool CAPS; Morningstar; *for next fiscal year.

Naturally, this is not a list of stocks to buy and sell, but rather a starting point for further analysis. Investors have raised their outlook significantly on these companies, and it may mean there is still room to move.

A fine mesh filter
DRDGOLD does hold risks for investors, but as a junior miner it may have greater upside potential. Analysts focus more closely on its larger brethren like Goldcorp (NYSE: GG  ) and Barrick Gold (NYSE: ABX  ) ; DRDGOLD has only two analysts covering it, compared with 16 and 22 for its rivals, respectively. The South African rand is weak against even the dollar, and the power outages in that country could continue to bedevil the miner. Yet finding winning stocks over the past decade has often required digging for small-cap stocks that were both obscure and ignored by Wall Street.

Understanding the risks involved has led investors like CAPS player KipLargo to recommend a dual strategy of buying the junior miner alongside one of the major players.

They own all their equipment and have a good forward outlook. Still a risky stock simply because they're small, and small miners have a lot of risk factors simply because of the circumstances unique to the mining businesses. If you actually want to buy this stock, split the money you have for this between them and a well established [precious] metals miner, like Yamana or Barrick.

Take a bow in CAPS
There are many ways to screen for stocks to beat the market. You can use the new CAPS screener to find other stocks you're going to want to own, but if you want to see what other stocks CAPS investors are marking up to four and five stars, head over to Motley Fool CAPS now -- it's completely free to join.

Wal-Mart is a Motley Fool Inside Value recommendation. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Rich Duprey owns shares of Wal-Mart but does not have a financial position in any of the other stocks mentioned in this article. You can see his holdings. The Motley Fool has a disclosure policy.


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