Wednesday's Biggest Stock Stars

Hey there, Fools. I've summoned our Motley Fool CAPS community once again to highlight Wednesday's biggest gainers among the stocks with a top rating of five stars.

Without further ado:

There's a simple reason I selected the largest five-star gainers, as opposed to other big-name winners making noise on Wednesday, such as low-rated DryShips (NASDAQ:DRYS): Stocks go up all the time, but unless you were able to predict the pop, what does it matter?  

Our community of more than 105,000 CAPS Fools considers its five-star stocks the most likely to outperform the market. And so far, CAPS has indeed proved its market-beating prowess: Over its first year, top-rated stocks returned roughly 28%.

Written in the (five) stars?
For example, out of the 524 CAPS players who've rated Motley Fool Hidden Gems Pay Dirt pick Cogent, 97% have a bullish opinion. On the strength of that support, the small-cap provider of fingerprint-identification systems recently regained its five-star rating.

Three months ago, CAPS player PrincetonAl positively identified some of Cogent's bullish qualities:  

Best-in-class technology (fingerprinting)? Check. Riding a megatrend (security)? Check. Wildly misunderstood with a decent margin of safety and FUD (fear, uncertainty, and doubt) swirling around to drive down the price on a lumpy earnings model? Check.

Cogent has risen more than 30% since that call. In fact, yesterday's pop came after the company said its first-quarter profit more than doubled -- right in line with PrincetonAl's take.

The bullish lesson?
Focus on finding low-risk, high-uncertainty situations. There's nothing Wall Street loves more than smooth, steady, and predictable earnings growth, but some of the best bargains can be found among companies whose cash flows are naturally more volatile. As Warren Buffett said, "We prefer a lumpy 15% return to a smooth 12% return."

And now for the losers …
Of course, winning isn't everything in the stock market. Here are Wednesday's biggest one-star decliners:   

One-star stocks generate the least confidence from our CAPS players. So although yesterday's drop in highly rated Shanda Interactive Entertainment (NASDAQ:SNDA) may have caught our community off-guard, one-star stocks are fully expected to fall hard. In the first year, CAPS' lowest-rated stocks dropped an average of 16.6%.

Did CAPS call the fall?
Last January, for instance, CAPS All-Star AnomaLee aimed this bearish letter directly at KeyCorp:

Dear KeyCorp,

... I've seen your tall building and I know that you're headquartered in Cleveland, OH. That's my hometown and I must admit that the local economy is just terrible. I'm very disturbed to hear that of the 16 states you service that most of your business is primarily in some of the weakest economic areas of our country … in the mid-west.

I also fear that you will be wiping away your dividend to ease your current problems of cash flow. ...

Sincerely and Best of Wishes,

A frequent user of your bank.

Consistent with that pitch, shares of KeyCorp plunged yesterday after the regional bank said it expects 2008 loan charge-offs to be significantly higher than previously anticipated.

The bearish takeaway?
Get out of dangerous locations while you can. Just as companies with very little product diversification should give Fools some pause, those that are overly exposed to just a few geographic regions should cause concern. When things are booming, geographic risk might seem trivial, but as KeyCorp demonstrates, any material troubles in those areas could spell doom for investors.

The final Foolish move
Investors often focus strictly on stock price movements without realizing that developing a proper stock-picking process counts most.

Over at Motley Fool CAPS, thousands of investors are Foolishly sharing insightful investment tips to help, above all else, identify tomorrow's big movers. Over time, consistently reverse-engineering winning -- and losing -- stocks will help you become a more Foolish investor.

Log in to CAPS today, and start participating. It's absolutely free -- and a lot of fun!