5 Stocks Approaching Greatness

Some companies are obviously great investments -- in hindsight. Sure, we should have bought Starbucks at its IPO and earned hundredfold returns over the years. Yet for every stock out there screaming "buy me," others simply give us a nudge and a nod. How can we tell tomorrow's obviously great investments from the thousands of pretenders?

The stars' walk of fame
On Motley Fool CAPS, these opportunities can be found among our four-star stocks. In CAPS' proprietary ratings system, they rank higher than most of the other 5,300 rated companies, but they're just shy of superstardom. While all the attention might be focused on their five-star peers, we can sift through CAPS to find four-star firms approaching greatness:

• Oilsands Quest (AMEX: BQI)
• OmniVision Technologies (Nasdaq: OVTI)
• First Marblehead (NYSE: FMD)
• Penn West Energy Trust (NYSE: PWE)
• Smith & Wesson Holding (Nasdaq: SWHC)

Some of these names might surprise you. Smith & Wesson, for example, isn't exactly a hidden corporate name, as its history is entwined in the fabric of this country's westward expansion. Yet sometimes the most familiar names -- Smith & Wesson might best be known these days as Dirty Harry's preferred firearm -- can offer the best opportunities, if only because we've begun to take their potential for granted. The 80,000 CAPS investors collectively chose these companies as less obvious sources for tomorrow's great buys. Let's see why they might merit your attention.

First in its class
Considering the turmoil in the credit markets, you can't be faulted for thinking any company involved in the loan business is a risky investment. Certainly the markets have lumped student loan provider First Marblehead in with other lenders that are suffering from a severe case of the credit crunch blues. Some might see SLM (NYSE: SLM), with its failed buyout and having to resort to the public markets to raise cash, as laboring on its deathbed. Meanwhile, some subprime lenders, like New Century Financial, have had to declare bankruptcy.

Painting with a broad brush, however, is a mistake. While First Marblehead does sell its loans into the asset-backed securities (ABS) market -- a market which itself has been roiled because of high-risk mortgages being sold -- its student loans are far more solid. That's because the database it uses to size up borrowers, called TERI, has a long history of plucking out the best, thus providing the company with a measure of safety.

The markets are discounting that. However, one institution sees a golden opportunity here. In the past three months, First Marblehead's shares have shed about two-thirds of their value, pricing the firm at just over its book value and making it incredibly cheap by most measures. Goldman Sachs (NYSE: GS) has infused the student loan lender with $1 billion in debt financing while one of its affiliated funds will make a $260 million investment in its shares.

In his top-recommended pitch for First Marblehead last summer, CAPS All-Star investorpoet provides background on the lender's operations and then gives investors a valuation. While he may have been a little early in his analysis, it would seem the points he makes regarding the market's actions hold true today.

The market seems to be pricing First Marblehead as if they are going to lose 20% of their business next year and then grow at a rate of 11% for five years. I think the most reasonable and conservative valuation assumes a 14% 5-year growth rate with a reversionary P/E of 11.2. This results in a value of $71 per share.

Trading ranges are less important in this scenario because this company seems to be mispriced by the market. The P/E range has been from about 9x to 19x earnings. This suggests a range of $36 to $77 per share. Based on this analysis, the stock is trading at the approximate bottom of the historical P/E range.

Of course, not everyone thinks First Marblehead is out of the woods. The top bear pitch was penned by CAPS newcomer o2n2y, who thinks it's foolhardy to expect the credit and liquidity crisis to be over anytime soon. This investor writes that the business needs a much closer examination than it's been given, and that investors shouldn't base judgments on biased feelings of when the markets will settle down.

Maybe we ought to think about this opportunity as more than a Game, & ask some hard real questions about the changing face of FMD's business & not just the overhyped housing slump & credit crunch effect!!!

You can read full pitches from both the bulls and the bears here.

A great opportunity for you
You've heard from both sides on First Marblehead, but do you agree? Are these four-star stocks still investment-grade material? Your input on Motley Fool CAPS can ultimately influence how they're rated. Outperform or underperform, near-term or well in the future, your opinion counts.

Sign up today for Motley Fool CAPS; it is completely free.