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 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 Dreman of Dreman Value Management into aerospace and industrial products manufacturer Barnes Group at the end of March.

Over on Motley Fool CAPS, more than 60,000 professional and novice investors alike have rated more than 4,700 stocks by 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 Dreman yet, but their records are remarkable all the same.

The best of the best
All-Stars each boast a CAPS rating of 80% 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.

I'll have to admit that the value investor in me can't get beyond the large run-up in DryShips, and an oil exploration company like Transmeridian that can't generate a return in this day of heady fuel prices seems broken. Yet it does have a field in oil-rich Kazakhstan, and rumors have been spreading of a possible buyout.

It's also becoming apparent that CAPS investors are beginning to eyeball the housing market again, as both WCI Communities and Lennar are gaining attention. In the past, KB Homes caught a CAPS All-Star's eye, as did mortgage lender Countrywide Financial (NYSE:CFC).

Finding value under rocks
More interesting to me, even though its stock has been discounted the least over the past year, is Blockbuster. It has taken the first steps into another price war with archnemesis Netflix (NASDAQ:NFLX), and so far, the red rival has been the one bloodied. There are also some seeming miscues from Netflix -- though not everyone sees it that way -- that make Blockbuster as an investment seem plausible, if nothing else.

The end-to-end strategy that Blockbuster calls its Total Access plan seems to be the key to the bull argument. For example, top-rated CAPS player Immord is succinct: "two words: TOTAL ACCESS." Slightly more expansive is Happytiger, who says, "The Total Access program should help improve [earnings] and [bottom line]."

Apparently, the ability to rent a movie online and return it to a bricks-and-mortar store where you can exchange it for another movie will be a category-killer -- at least for the time being.

However, CAPS investor gfire77 sees more to Blockbuster than just the latest iteration of a rental strategy, though that certainly helps:

Even after its recent 50% run Blockbuster still has further to go. The bottom line here is that Blockbuster is making [a lot] of money. It had $168 million in free cash flow the last 4 quarters. That gives it a trailing enterprise value to free cash flow ratio around 13 -- cheap. As Total Access picks up and Blockbuster pays down some of its monster debt ($1 billion) free cash should increase even more. I agree that Netflix is a better, financially cleaner, business. But Blockbuster is a better value, both the business and stock have momentum, and therefore [BBI is] a better stock than the more expensive Netflix.

It's your turn
So there you have it -- four low-rated stocks that have gotten a big endorsement from some of the best and brightest investors in the CAPS community. What do you have to say? Will Blockbuster break Netflix? Will housing get rebuilt? If you want to add your two cents, sign up to join the Motley Fool CAPS community, which is 100% free.

Netflix is a recommendation of Motley Fool Stock Advisor. A 30-day risk free trial subscription gives you total access to all of the stock picks that are currently beating the market by 38 percentage points.

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.