Investor sentiment can be a powerful force in moving stocks. Think of it as a pendulum swinging in a company's favor. When investors begin to think highly of your company, it might be a sign that the stock will also start heading in the right direction.

Yet knowing when investors are beginning to warm up to a stock isn't always easy. Often, you can only tell after the stock has moved up -- but by then, it may be too late.

An astrolabe for investors
Investors at Motley Fool CAPS, however, have a way to monitor the progress of investor sentiment. Like every player on CAPS, each stock is given a rating from one to five stars, with five being the best. While the full "secret sauce" of how the ratings are calculated is proprietary, there are three factors that influence a stock's star rating:

  • Whether a stock is rated "outperform" or "underperform."
  • The length of time it is expected to take to achieve this performance -- a few months or a few years.
  • The ratings of the investors who make the picks.

Like astronomers scanning the skies, investors can then track the movement of the stars. A stock's CAPS rating trend shows how investors feel about the stock over time, whether its star rating is on the upswing or trending down.

Investors can then use this information to help decide whether it may be a good time to invest in the stock. Here we're looking at companies with the lowest ratings -- one and two stars -- that have seen investor confidence upgraded one notch higher. Below is a table listing some of the stocks that have seen the stars start to align for them.

Company

CAPS Rating

Recent Price

1-Year Return

ImClone Systems (NASDAQ:IMCL)

***

$42.47

44.3%

Progress Energy (NYSE:PGN)

***

$49.93

9.4%

DRDGOLD (NASDAQ:DROOY)

**

$7.73

(11.1%)

Insmed (NASDAQ:INSM)

**

$0.94

(16.1%)

Merrill Lynch (NYSE:MER)

**

$61.42

(31.0%)

Obviously this is not a list of stocks to buy, but rather a starting point for further research. Yet consider the example of financial and banking titan Washington Mutual (NYSE:WM), profiled last week, which saw its CAPS rating stay flat at two stars.

Around the start of November, WaMu's rating fell -- just as the news of its exposure to subprime lending hit. Investors were growing concerned about what the exposure would do, and it bounced between one and two stars. However, CAPS investors have recently marked up the rating again, so you have to keep your eyes on the stars. It's possible that this time, the improvement may have more to do with valuation than with the fundamentals.

Getting bullish on Merrill
Investment banker Merrill Lynch's mascot may be a bull, but investors could feel like they've gotten trampled by bad news lately. There have been more than a few major stumbles: overexposure to risky debt deals, disclosures of a worsening balance sheet, and a recent management change at the top. It's enough to make you want to grab the bull by the horns and put a stop to it. Perhaps someone has.

The bad news is finally out about its financial position, and hopefully we've seen the worst of it. New CEO John Thain has investors thinking he may bring some order to the company, just as he did at NYSE Euronext (NYSE:NYX).

That's part of the reason why CAPS player WBDisciple is giving Merrill Lynch his endorsement, as a new chief will rein in a company that has been running about like a bull in a china shop:

The departure of Stan O'neal has only 1 effect, the company will prosper. With such a poor judgment and absurd compensation pay he received, the company will do better in future. Good company has to be managed by good people and people with integrity. Taking home $50 million is absurd in this industry.

CAPS player ghostryder13 agrees, seeing the underlying core business of the investment bank as still being solid. The sound and fury surrounding its mortgage-backed securities debacle led the market to overreact -- as it usually does -- sending shares down more than was warranted:

Market overreacted to writedowns; once liquidity is restored to the FI markets a more reasonable valuation of the mortgage backed securities will be feasible. Core wealth and asset management still going strong; axing the CEO was a symbolic sacrifice to appease the media and analysts but underlying performance remains the same, and has been overall quite positive. ML just got unlucky betting on MBSs -- esp when they had to redefine a number of prime assets as potentially subprime (without a commensurate upside potential hike).

While Merrill bears see the credit crunch hurting the company's standing, at least in the short term, CAPS bulls are looking beyond the crisis of the day, anticipating that this bull will rampage on Wall Street once again.

Shine your starlight
We know where the CAPS bull and bear positions are, but we haven't yet heard from you. At Motley Fool CAPS, every investor's opinion counts. Weighing in with yours could be the difference between these stocks becoming shooting stars or supernovas. It's free to sign up, and free to post your thoughts -- use this opportunity to take your star turn.

Washington Mutual is a recommendation of Motley Fool Income Investor, where for 30 days you can check out all the stock selections risk-free. NYSE Euronext is a Rule Breakers selection.

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.