Surprising 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 Buffett's finding opportunity in bonds, perhaps you should look there, too. Does Bill Miller think financial stocks are beaten down? Maybe investigating more closely will help improve your own results.

Over on Motley Fool CAPS, our top-rated All-Star players represent the best 20% of our more than 110,000 professional and novice investors. I'm looking among them for players who've chosen one- and two-star stocks to outperform the market. The majority of CAPS investors may consider these stocks losers, but if our ace contrarians think otherwise, these picks might be worth a look.

Here are a few stocks that have gotten the nod from the cream of our CAPS investors:

Company

CAPS Rating (out of 5)

Est. Long Term EPS Growth

CAPS All-Star

Player Rating

AMR (NYSE: AMR  )

*

25%

seedrop

99.60

Continental Airlines (NYSE: CAL  )

*

13%

jstegma

99.57

Meritage Homes (NYSE: MTH  )

*

5%

klemenv

99.52

Overstock.com (Nasdaq: OSTK  )

*

20%

zeeFrenchGuy

96.01

Pulte Homes (NYSE: PHM  )

*

15%

bdash

95.57

Source: Motley Fool CAPS; Yahoo! Finance.

Crash and burn
Airlines and homebuilders seem to be among the worst places to invest these days, yet a number of smart CAPS members are browsing through the most distressed companies in search of the best bargains. That's often a sound contrarian strategy to stake out.

AMR, the parent company of American Airlines, reported earnings today, posting a loss at least partly because of high fuel prices. Delta (NYSE: DAL  ) , which also announced earnings today, actually hedged almost half of its fuel consumption, realizing $313 million in gains there; still, it ultimately posted a $1 billion loss for the quarter. Its proposed merger with Northwest Airlines (NYSE: NWA  ) would supplant American as the world's largest airline.

As troubled as the industry is, and as much as Buffett doesn't like airlines, some investors find the potential for gain too big to pass up. Investors like CAPS member ChimpInvestor think a "basket approach" to the industry will turn up some airlines that ultimately enjoy monster growth, as he notes in a response to another member's pitch:

I love thinking like this.. i put real money on AMR and did a basket of picks too... worst case scenario 5 of the 15 airlines i green thumbed will go bankrupt for -100%, but the ones that survive from these ridiculously depressed levels will be up 2 to 4 fold... look at a lot of the foreign airlines who are still making money at 140 oil... the industry needs to consolidate, hedge, and take other actions to bring long term value... the industry is TOO important to fail.

Continental will follow with its earnings release tomorrow, and not surprisingly, analysts aren't expecting much from the carrier. It's already announced plans to slash 3,000 jobs, reduce capacity, and mothball 67 aircraft by the end of next year. Cost-cutting is the watchword of the industry, along with dinging passengers with nickel-and-dime charges for meals, drinks, and baggage.

Given the pressure of airlines' changing economic picture, some investors can't help believing that their already low values  have more room to fall. CAPS member JoyofMoney thinks the probability of more turbulence for Continental will only increase:

I don't like the EPS estimates for 2008 and 2009, don't like the high debt/equity ratio, and this should have enough volatility to be really hurt by high oil pricing. A big company which will have to cut somewhere to save and I do not see where it is going to without hurting the consumer with either less flights, less service, and more expensive baggage handling. I may be on the late side on an entry with a down thumb but I think there will be more trouble in the near future than not.

Shorts in a bunch
It looks like the SEC is finally listening to Patrick Byrne, CEO of Overstock.com, who has been railing for years about the nefarious deeds of "naked short-sellers," who sell a stock short without actually trying to borrow the shares first. The SEC is at least going after some short-sellers, imposing a 30-day moratorium on naked short sales on a host of troubled financial firms; it's also considering extending the rule to all stocks.

Byrne has complained that Overstock's shares have been the victim of naked short-selling for years. He points out that Overstock.com has been on the SEC's Regulation SHO list -- which tracks naked short-selling -- 95% of the time. Ironically, Overstock.com dropped off the list about a week and a half ago, after 130 consecutive days on it.

While SEC vindication may have a soul-soothing effect, investors like CAPS member jahartmu remain concerned that Overstock's business model simply won't support it with so many other alternatives available:

Friends have purchased the occasional item there, but I don't know of anyone who loves overstock.com or even shops there with any frequency. With so much competition from Amazon, Wal-Mart, Lowe's, and even pricier retailers who sell clearance merchandise through their websites, I cannot imagine an online only company with a kludgy website remaining in business over the long term.

Finding value under rocks
So there you have it -- five low-rated laggards that have gotten big endorsements from some of the best and brightest investors in the CAPS community -- although others disagree. If you want to add your two cents on these or any other stocks, sign up to join Motley Fool CAPS, absolutely free.

Meritage Homes is a Motley Fool Stock Advisor recommendation. Try any of our Foolish newsletters today, free for 30 days.

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.


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