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 you'd bought Ingersoll-Rand when Warren Buffett announced his small stake in this industrial company last February, you'd be enjoying a roughly 21% gain so far. You'd be up about 55% if you'd followed David Dreman of Dreman Value Management into aerospace and industrial products manufacturer Barnes Group at the end of March.

In Motley Fool CAPS, more than 71,000 professional and novice investors alike have rated more than 5,000 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 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 90% or better. Then I searched through this set of players to see who'd chosen one- and two-star stocks to outperform the market.

Why low-rated stocks? Just like the players, stocks receive CAPS ratings, too, from one to five stars. The majority of CAPS investors may think these 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 five one-star stocks have gotten the nod from the cream of our CAPS All-Stars:

Typically, this list contains at least one low-rated stock that's also enjoyed a large one-year run-up in its stock price, leaving me leery of considering it as a possible investment. Not that stocks can't continue to run, but their high valuations-- even with their low ratings -- leave me a little cold. But this week, only Sony has any sort of appreciable gain -- and nothing so large that I might get dizzy.

Although Bear Stearns had one of the largest losses of the companies profiled, it doesn't show the full extent of the fall. The stock had been trading as high as $172, which would make its decline a sharper 33% falloff. Still, I tend to agree with CAPS player oldnbroke441 that it might be worth a look. Stuck with hedge funds filled with too many exotic securities that couldn't withstand the market's downturn, the once-venerable investment house found itself having to bail them out with an infusion of billions of dollars. However, Bear Stearns probably won't be closing shop any time soon.

That's exactly what CAPS investor FleaBagger likes about the opportunities investor overreaction can provide:

This is what value investing is all about. A good (in the profits=morals sense) company takes a hit because of a one-time problem, and everybody gets the chance at 40-80% returns from a big cap. Yay! Also, I like green-thumbing a one-star. It's the petulant side of me.

Those sentiments are echoed by ixgryyk, who believes the investment banker's swift action to shore up the gaping hole left by the hedge funds marks it for a turnaround:

The bad: BSC took a gigantic beating after huge losses in funds with heavy exposure to bad debt.

The good:
* This is a one time loss, future outlook hasn't changed much (and future outlook is good!).
* [Bear Stearns] bailed out its customers. I like the fact that [Bear Stearns] is taking full responsibility. The value of this company is not in short-term profits but in selling services over the long run, and that means gaining and keeping customer trust.
* Was very quick to disclose the full extent of its problems and take appropriate corrective measures.
* It's trading for CHEAAAP!

While the collapse of two funds is indicative of some unwise decisions and unreasonable risk made by the company, the extent to which it is trying to fix things is reassuring [to] me. This looks like a company that learns from its mistakes and is probably doing more than others right now to make sure that this doesn't happen again. My verdict: it won't stay cheap forever.

Finding value under rocks
So there you have it: five low-rated laggards that have gotten a big endorsement from some of the best and brightest investors in the CAPS community. What do you have to say? If you want to add your two cents, sign up to join the Motley Fool CAPS community, which is 100% free.