Low-Rated Stocks the Leaders Love

Piggybacking on the picks of great investors and money managers can often lead to big rewards -- especially when the stocks in question are beaten down.

If you'd bought Ingersoll-Rand (NYSE:IR) when Warren Buffett announced his small stake in this industrial company last February, you'd be enjoying a roughly 28% gain so far. You'd be up another 43% if you'd followed David Dremen of Dremen Value Management into aerospace and industrial products manufacturer Barnes Group (NYSE:B) at the end of March.

Over on Motley Fool CAPS, more than 30,000 professional and novice investors alike have rated more than 4,700 stocks, indicating whether they think those companies will beat the market or lose to it. The best investors, those who consistently outperform their peers, are considered All-Stars. They might not match Buffett, Lynch, or Dremen yet, but their records are remarkable all the same.

The best of the best
All-Stars each boast a CAPS rating of 85% or more. That's plenty good, but I wanted to see which companies the very best All-Stars were choosing. I searched CAPS for players with a rating of 95% or better. Then I searched through this set of players to see who'd chosen one-star stocks to outperform the market.

Why one-star stocks? Just like the players, stocks receive ratings too, from one to five stars. The majority of CAPS investors may think these one-star stocks are dogs, but our top All-Stars believe they'll have their day. It's a typical contrarian investor concept -- what value investing legend Benjamin Graham called "picking up cigar butts."

These four one-star stocks have gotten the nod from the cream of our CAPS All-Stars:

My inner value investor cares little for NVE, considering the large run-up it's had. Despite its reported revenues and earnings growth last month, I find myself siding with another All-Star, LoneIguana, who writes:

Far too much starry-eyed hopes for MRAM to be the next wave in solid-state storage. Consistent manufacturing is an issue, which produces fairly low yields with today's processes, which is an intrinsic supply problem even if MRAM lives up to the hype. NVEC is an outright gamble, and I'll put my money on the down side.

Nor am I too keen on the airline industry. Certain segments are performing well, but there are serious structural defects built into the entire business.

Finding value under rocks
Instead, I find myself leaning toward biopharmaceutical company MannKind and homebuilder KB Homes. The biotech has a promising inhaled insulin treatment that could revolutionize the way diabetics take their life-saving drug. With insulin injections currently valued at around $21 billion, an inhalable delivery mechanism would surely capture a huge swath of that market.

In particular, KB Homes and a few other homebuilders seem ripe for the picking. There's little doubt that the housing industry has taken it on the chin lately, as subprime mortgage woes, declining home prices, lower sales, and the need to offer greater incentives has taken its toll. Sounds like a wonderful time to invest!

John Neff, another value investing legend, regularly recommended buying a beaten-down company before it became apparent a turnaround was in place. By that point, everyone knew things would be getting better, and the price had been bid up. While KB Homes is only down 8% year over year, it's down nearly 25% from the high point reached in February, when most analysts had assumed the housing crisis would ease. When it didn't, homebuilders' stocks fell hard.

As CAPS All-Star hondo928 notes:

This is long-term no clue when the housing market will turn around or if it's time to buy in now, or if we all should wait more, but the value is good and as Mr. Graham says don't be worried by the day to day because the intelligent investor is concerned with the long-term. Well I'm going long on this one as it was oversold and should have plenty of upside once the cycle turns around.

It's your turn
So there you have it: four low-rated stocks that come highly endorsed by some of CAPS community's best and brightest investors. What do you have to say? Will housing build itself back up, or is the airline industry poised for a takeoff? If you want to add your two cents, sign up to join the Motley Fool CAPS community, which is 100% free.

Find more of Wall Street's most promising bargains with a free 30-day trial to Motley Fool Inside Value.

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