The Best Stocks to Buy and Sell

A year or so ago, you'd have been a genius if you'd bought energy stocks and sold financial stocks. Among the stocks of the S&P 500, the energy sector is up 10% over the past year, while financials are down an abysmal 48%.

If only we knew.

An investing tool worth its weight in oil
Some of us did know. Our Motley Fool CAPS database offered invaluable guidance on a number of stocks in both the financial and energy sectors. For example, despite Fannie Mae's (NYSE: FNM  ) impressive return of 38% from July 21, 2006, to July 21, 2007, our CAPS community gave the company just one star back in July 2007 -- the lowest rating possible.

As we all know now, the mortgage giant has seen its shares decline by more than 75% in the year since then. The following table shows similar results for Freddie Mac (NYSE: FRE  ) and MBIA (NYSE: MBI  ) .

One-Star Stocks From Last Year

Company

Year-Ago CAPS Rating (out of five)

One-Year Return Prior to July 2007

One-Year Return Since July 2007

Fannie Mae

*

38%

(77%)

Freddie Mac

*

8%

(85%)

MBIA

*

2%

(91%)

Data from Motley Fool CAPS and Yahoo! Finance as of July 21, 2008.

CAPS offered up equally useful insights on several energy stocks. For example, Petroleo Brasileiro (NYSE: PBR  ) , commonly known as Petrobras, delivered outstanding returns of 70% from July 21, 2006, to July 21, 2007.

Our community gave the company a five-star rating a year ago, and Petrobras went on to achieve 71% returns in the subsequent year. The table below tells a similar story for Chesapeake Energy (NYSE: CHK  ) and Transocean (NYSE: RIG  ) .

Five-Star Stocks From Last Year

Company

Year-Ago CAPS Rating (out of five)

One-Year Return Prior to July 2007

One-Year Return Since July 2007

Chesapeake Energy

*****

29%

54%

Petroleo Brasileiro

*****

70%

71%

Transocean

*****

55%

35%

Data from Motley Fool CAPS and Yahoo! Finance as of July 21, 2008.

Ultimately, our CAPS community had 20/20 foresight when it came to this very small group of energy and financial stocks. Don't get me wrong, however. CAPS didn't always get it right for each individual five-star stock or one-star stock. What we're finding so far is that our CAPS rating appears to have predictive capabilities across an average of all stocks within a given "star" portfolio.

The value, dear Brutus, is in our stars
Across the approximately 5,500 stocks in our database, there is striking evidence of the predictive nature of our CAPS rating. My colleague Tim Hanson first wrote about our returns data back in November. Below I've provided updated returns on a portfolio of stocks with a particular star rating:

Stock Group

Annual Return

Beta

Five-Star

12.1%

1.14

Four-Star

7.1%

1.11

Three-Star

0%

1.08

Two-Star

(5.0%)

1.04

One-Star

(11.4%)

0.79

SPDRs (AMEX: SPY  )

(0.1%)

1.00

Internal data from Nov. 6, 2006, to July 3, 2008.

The table provides returns for each star category as stocks come in and out of that particular rating. Returns are calculated on a forward-looking basis for those stocks that are in the particular "star portfolio."

As you can see, despite all of the recent market turmoil, five-star stocks outperform the market by 12%, while one-star stocks underperform by roughly 11%. According to this data, investors would do well to look for new ideas among five-star stocks, while potentially unloading one-star stocks.

Keep in mind, though, that these returns are for an average of each star-rating, so you'll still need to do due diligence on specific five-star stocks. (In other words, this information can inform your research -- it's not meant to replace it.)

Getting in on the ground floor
So how can you benefit from this information? The easiest way is to utilize our CAPS screener to identify five-star stocks for further research. By looking for winners among a portfolio of stocks that outperform the market -- that is, by fishing in a richer pond -- you might increase your odds of success considerably.

So join our free CAPS service today and take our screener out for a spin. As the database gets smarter, the relative performance of our ratings should get even better. And that will be great news for ordinary investors.

John Reeves does not own shares in any of the companies mentioned in this article. Having waited in line for the restroom at various sporting events over the years, he's not fully convinced of the "wisdom of crowds." The Motley Fool owns shares of SPDRs. Chesapeake Energy is a Motley Fool Inside Value selection. Petrobras is an Income Investor selection. The Motley Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (62)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 24, 2008, at 12:21 PM, Ishortyou wrote:

    According to the rating agencies specially Moody's, it doesnt look that bond insurers need to have adequate capital to be triple A rated but also get rid off liabilities, specially CDO's-ABS-SIV or any structured finance from its books, so hopefully the bond insurers like AMBAC or MBIA are remdiating their books from these liabilities as soon as they can to regain their triple A again.

  • Report this Comment On July 27, 2008, at 11:27 AM, IBleedConcrete wrote:

    John - your table above which lists the "Annual Return" of the star groups fails to note whether this is less the market. In fact SPDRs lost approximately 2.65% compound annualized over this time period. On 6 November 2006 SPY cost $138.08, while on 3 July 2008 it cost $126.31, with $4.81 in dividends along the way.

  • Report this Comment On August 01, 2008, at 11:11 AM, JesterWOCourt wrote:

    Is the chart saying that a 5 star stock in November 2006 yielded those returns or a 5 star stock today yeilded those returns since November 2006?

    I probably sound like a fool. I've yet to participate in CAPS, but it seems the ratings would be skewed as people rate things after a stock has begun to climb.

    Set me straight.

  • Report this Comment On August 04, 2008, at 4:23 PM, TMFJake wrote:

    Each rating quintile is treated as an index and measured over the 11/06-7/08 time series. To use the 5-star stocks as an example, we are NOT looking at stocks that recently achieved 5-star status and looking at their TTM returns. We ARE measuring the performance of stocks that have already achieved 5-star status over a time series. That is to say, on 11/06, all stocks that had achieved 5-star status are included in the 5-star index. Throughout the time series, stocks would be added or removed from the 5-star index depending on whether they crossed into or below the 5-star rating threshold.

    Hope that helps! And come join us on CAPS JesterWOCourt!

  • Report this Comment On February 06, 2009, at 6:57 PM, Helphelphelp wrote:

    Where do I find stocks for google?

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