Hidden Stocks for High Returns

Like the song says, investors are looking for stocks to love in all the wrong places. They'll pile into the momentum stocks everyone else buys, but ignore lesser-known opportunities for fear of straying from the crowd. Overlooked by Wall Street and Main Street, and thus undervalued, these stocks hold the best potential to deliver outsized returns.

The Motley Fool CAPS community knows a bargain when it sees one. Below, you'll find several under-the-radar stocks that brim with promise. These companies have garnered 100 or fewer active recommendations on CAPS, though the community thinks they still have outsized potential.

Stock

CAPS Rating
(out of 5)

No. of Active Picks

Est. EPS Growth Next Year

Arcos Dorados (Nasdaq: ARCO  ) ***** 94 NA
ARMOUR Residential REIT (NYSE: ARR  ) ***** 13 (18%)
Federal Agricultural Mortgage (NYSE: AGM  ) **** 81 NA

Source: Motley Fool CAPS; NA = not available.

Naturally, we want you to look a bit closer at these stocks before buying. Maybe investors are staying away from these stocks for a reason, so make sure there's nothing seriously wrong with a company before you plug it into your own portfolio.

Blinded by the light
The stock chart of newly IPO'd Arcos Dorados is starting to look like the front half of McDonald's (NYSE: MCD  ) golden arches, a big, inverted "U." That's not just an idle comparison either. Arcos Dorados is the owner of Mickey D's Latin American operations, which it bought back in 2007 when the burger joint was divesting itself of everything that didn't relate to its core business or was distracting management's efforts.

While McDonald's saw the birth of Chipotle Mexican Grill (NYSE: CMG  ) as a stand-alone concept at that time (and a short time later got out of both Boston Market and then Redbox, the movie rental kiosk joint venture with Coinstar), McDonald's management wasn't so crazy that they didn't keep a piece of the action for themselves.

The deal certainly looks pretty sweet for McDonald's, at any rate. It gets 50% of the initial franchise fee that a franchisee pays to Arcos, then it gets a continuing franchise fee equal to 5% of the store's gross sales for the first 10 years, 6% for the next five, and then 7% after that. It's probably not so bad for Arcos either, as the demographic trends in Latin America favor strong growth, particularly in Brazil, which accounts for more than one-third of its revenues.

Considering it just went public, the fact that it's already racked up strong support among CAPS community members is surprising. CAPS member trhdawg sees it as a play on emerging markets:

long term play on emerging markets, goes in line with my agricultural plays. Even though its a holding firm for mcdonalds brand in south america, profits rise when incomes in those nations rise. plus who doesn't love their cheeseburgers?

You can flip your own thoughts on its future on the Arcos Dorados CAPS page.

Under the radar
Investing in the U.S. housing market, even if it's through the guarantees issued by Fannie Mae and Freddie Mac, seems like an awfully risky business these days to attract the unanimous sentiment of CAPS members, as ARMOUR Residential REIT has done. Even American Capital Agency (NYSE: AGNC  ) and Annaly Capital Management (NYSE: NLY  ) , two very popular REITs with insanely attractive dividends, have their detractors.

There's good reason, too. In addition to the political sentiment building up that Fannie, Freddie, and all their red-headed stepchildren should be cut loose from the taxpayers' trough, they're still subject to interest rate risk and have large exposure to leverage.

Yet the members who've rated ARMOUR on CAPS think it will outperform the indexes, though even bullish member HermannGoering wonders about the longer-term outlook: "Looks like management is putting the new risk management software to good use. The question is how will they do after the end of June?"

You can build a case for growth on the ARMOUR Residential REIT CAPS page or add it to your watchlist.

Divine intervention
Speaking of federally chartered offspring, Federal Agricultural Mortgage -- better known as Farmer Mac -- reported first-quarter results the other day that showed continuing improvement in its portfolio, if it didn't say as much about the overall economy.

For example, 90-day delinquencies tend to bounce around quarter to quarter, but are usually higher in the first and third quarters because of the way loan payments are structured. However, in the first quarter of 2011, such delinquencies actually decreased and it had no 90-day delinquencies among ethanol producers (which have made up a large portion of historical delinquencies) or utilities.

Is that because so many ethanol producers have gone bankrupt, like VeraSun Energy, Aventine Renewable Energy, and subsidiaries of Pacific Ethanol? Farmer Mac doesn't say, but it did sidestep a lot of the financial shenanigans that tripped up cousins Fannie and Freddie, and investors are generally bullish about its prospects. More than three-quarters of the CAPS members rating Farmer Mac believe it will outperform the market.

Add the stock to the Fool's free portfolio tracker then head over to the Farmer Mac CAPS page and plant the seeds of your opinion.

Keep a high profile
You need to look beyond headlines and press releases to get a fuller picture of where your money is going. Motley Fool CAPS is a great place to start that process.

Chipotle Mexican Grill is a Motley Fool Rule Breakers pick and a Motley Fool Hidden Gems recommendation. McDonald's is a Motley Fool Income Investor pick. The Fool owns shares of Annaly Capital Management, Chipotle Mexican Grill, and Coinstar. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. 

Fool contributor Rich Duprey does not have a financial position in any of the stocks mentioned in the article. You can see his holdings here. The Motley Fool has a disclosure policy.


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