7 Surprising 1-Star Stocks

Looking at some tracking portfolios set up in The Motley Fool's CAPS community, it's interesting to see how the CAPS members -- all 17,000 of them at this point -- have done picking stocks. The CAPS5StarIndex, for instance, takes 200 five-star stocks and holds them for a month, then rebalances to correct for any stocks that fell out of five-star status during the month. That portfolio has stayed pretty consistently above the 90th percentile of all CAPS players. Similarly, CAPS5star1star has done quite well by putting outperforms on five-star picks and underperforms on one-star picks. Surprises do happen, though, and there are bound to be unloved stocks that just can't be held down by lack of investor enthusiasm.

Here are this week's scorching seven, as identified by your fellow Fools on CAPS. Each of the companies below had been given a one-star rating (the lowest) by our community of investors just 30 days ago:

Of the seven, three managed to climb out of the one-star doldrums -- WR Grace, Wet Seal, and Acme Packet all moved up to two stars. The other four, however, were unable to convince CAPS members that they deserved to move up in the world.

WR Grace wrasslin' with the courts
WR Grace is one of a number of companies that have been under the specter of asbestos litigation for past sins. Besides WR Grace, the group includes former Lynch favorite Crown Cork & Seal, now known as Crown Holdings, and USG, a company that Warren Buffett has taken an interest in through Berkshire Hathaway.

Although the three companies have the dark cloud of asbestos in common, the businesses and, more importantly, current circumstances are not all on the level. On the business side, WR Grace is the most diversified of the three and sells into the specialty chemical, construction products, and packaging markets. The company is a worldwide leader in specialty chemical catalysts used by petroleum refiners to turn crude oil into useable transportation fuel. The business side of things continues to chug along, and on the top line, the company grew 13% between 2004 and 2005 and showed the same growth year over year for its recently reported third quarter.

Business isn't everything right now for WR Grace, though, as ongoing litigation regarding its exposure to asbestos settlements, as well as its Chapter 11 status, are keeping a big question mark over the company. Judging by the current five-star rating of USG, it may be very possible for WR Grace to settle with asbestos claimants (which USG did earlier this year for $4 billion) and emerge as a solid company -- although getting an investor like Buffett on board wouldn't hurt, either. Though the recent price run-up suggests that investors are feeling optimistic about WR Grace's legal future, for now, shareholders still remain vulnerable to the vagaries of the courts.

More than just anvils
This isn't the Acme you remember from Looney Tunes, but with a current two-star CAPS rating, it's up for discussion whether those buying Acme Packet's stock are a bit loony in their own right. As the chart above shows, they were certainly loony all the way to the bank last month as they racked up 25% over the last 30 days.

Acme entered the public markets back in October through an IPO headlined by Goldman Sachs and Credit Suisse. The company makes session border controllers (SBCs), which are used by service providers to deliver high-value services, such as voice or video, over internet protocol (IP) networks. Acme's SBCs basically act as a go-between at the borders of IP networks to ensure reliability and security of these data flows so that, for example, a VoIP phone call can function as reliably as a traditional phone call over the old-school telephone network.

The stock's current multiple of 39 times 2006 EPS estimates is backed up by some blazing 158% year-over-year revenue growth for the first nine months of 2006 and rapidly expanding operating and net margins. The future growth prospects are a bit cloudy, though. In its IPO prospectus, the company claimed that the market for SBCs is estimated by one research firm to be growing from $86 million in 2005 to $571 million in 2009. While that sweet 60% CAGR would create a lot of opportunity for Acme, it also creates a lot of risk.

The stock is already priced for strong growth, so if the market doesn't unfold quite as planned, Acme's performance could be less than investors are expecting. More importantly, though, an $86 million market may not be high up on the radar screen for larger companies. However, as this market gets bigger, it will attract more aggressive competition from players already entrenched in providing network guts. As noted in Acme's prospectus, Juniper Networks entered the SBC market through an acquisition, while Cisco recently announced a new SBC product. For Acme, which sees a good portion of its revenue from a few customers -- two customers accounted for 32% of Acme's revenue for the first nine months of 2006 -- the loss of even a handful of well-targeted customers could mean big trouble.

So is it time to pick up some of these unloved CAPS stocks? I'm not sure myself, but at the very least, they are excellent candidates for further due diligence. In the meantime, get in the game and get yourself heard. You'll also be able to read timely analysis from our community, and perhaps offer your own pitch for one of these stocks. CAPS is entirely free, and it's definitely a place where "the more the merrier" is actually true -- unlike one of those rickety old New York elevators.

Eager for more surprises?

• Check out last week's surprises.
• Take a look at Acme when it was hot off the press.
• Glance over Wet Seal's quarter.

Berkshire Hathaway is an Inside Value selection. You can find out why, and gain access to all past picks, with a 30-day free trial .

Fool contributor Matt Koppenheffer still gets most of his anvils from the Acme in Toontown, and avoids stocks that are falling like anvils. He (and Warren) own shares of USG, and he also owns Goldman Sachs shares, but he has no stake in any of the other companies mentioned. The Fool's disclosure policy is never surprising.