Tuesday's Hottest Stocks

Hey there, Fools. I've summoned our Motley Fool CAPS community once again to highlight a few of Tuesday's biggest winners among the stocks with top ratings of four or five stars:

There's a reason I selected those notable gainers, as opposed to other winners making noise on Tuesday, like low-rated mortgage insurers PMI Group and Radian Group. Stocks go up all the time, but unless you were able to predict the pop, what does it matter?

Our community of more than 150,000 CAPS Fools considers its high-star stocks the most likely to outperform the market.

Written in the (five) stars?
For example, 97% of the 139 All-Star members who've rated Motley Fool Rule Breakers pick Interactive Intelligence have a bullish opinion of the stock. In late 2008, one of those top Fools, djwhr1, explained why the stock seemed like an intelligent choice: "Great small company with a very successful products and good service and maintenance revenues. Good cash position with no debt. Management seems competent and focused on longer term performance. Low float."

Including yesterday's market-bucking pop, shares of the call center software specialist are up an impressive 140% since that call.

The bullish lesson?
Know when to break the rules. Small-cap growth stocks are notoriously fraught with risk, but by seeking those with genuine disruptive technologies, recurring revenues, and rock-solid balance sheets, you can reduce your downside substantially. As Warren Buffett recommends, "Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio's market value."

And now for the losers ...
Of course, winning isn't everything in the stock market.

Here are five of Tuesday's biggest decliners with one- or two-star ratings:

While yesterday's plunge in highly rated Patriot Coal (NYSE: PCX) may have caught our community off guard, low-ranked stocks are fully expected to fall hard.

Did CAPS call the fall?
Just last month, for instance, CAPS All-Star MichalTod strongly advised Fools to wave goodbye to Palm:

Palm is just too far behind the competition to catch up; it has not done well versus Android phones and I can't imagine it will do well against the iPhone. The current market valuation assumes the Pre will be a smashing success. I expect much lower prices in the next year as it becomes clear this once great company is going nowhere.

Shares of the smart phone maker are already down 31% since that warning. In fact, yesterday's plunge came on concerns that Palm's recently released phones through the Verizon (NYSE: VZ) network aren't selling as well as expected.

The bearish takeaway?
Never underestimate the protection that a competitive advantage provides. Having a powerful moat is what ultimately drives superior returns on capital, so unless you can clearly identify how a given company has an edge on its rivals, it's probably best to stay away. As Buffett reminds us, "The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage."

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 identify tomorrow's big movers. Over time, consistently reverse-engineering winning -- and losing -- stocks will help you retire wealthy.

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