Friday's Biggest Stock Stars

Hey there, Fools. I've summoned our Motley Fool CAPS community once again to highlight Friday's biggest gainers among the stocks with a top rating of five stars.

Without further ado:

There's a simple reason why I selected the largest five-star gainers, as opposed to other big-name winners making noise on Friday, like one-star stock Ford (NYSE:F). Stocks go up all the time, but unless you were able to predict the pop, what does it matter?  

Our community of more than 110,000 CAPS Fools considers its five-star stocks the most likely to outperform the market. And so far, CAPS has indeed proven its market-beating prowess: Over its first year, top-rated stocks returned roughly 28%.

Written in the (five) stars?
For example, out of the 50 CAPS All-Stars who've rated Hercules, just one has a bearish opinion. Fueled by that Foolish support, the specialty chemicals maker recently regained its five-star rating.

One year ago, CAPS player pwv77 explained what made Hercules so strong:  

This is a business that would make you snore. In the pyramid of manufacturing you don't get closer to the ground floor than chemicals, polymers and resins... It sports a widest margin in its specific industry, and controls expenses well. Return on equity is highest in its category, as is its growth.

Consistent with that call, shares of Hercules surged on Friday after fellow chemical maker Ashland said it would buy the company for $2.6 billion in cash and stock -- a deal that Ashland says should enhance its product offering, while reducing earnings volatility. 

The bullish lesson?
Always think like a business owner. All sorts of noise can depress a stock's price in the short term, but true investors are able to focus on the factors that really count over time. By buying well-positioned, internationally diversified, and, most importantly, cash-rich companies at good prices, you give yourself plenty of "upside" opportunities to earn an outsized return -- including a buyout by the big boys.

And now for the losers ...
Of course, winning isn't everything in the stock market. Here are Friday's biggest one-star decliners:   

One-star stocks inspire the least confidence from our CAPS players. So although Friday's drop in five-star stock Infosys (NASDAQ:INFY) may have caught our community off-guard, one-star stocks are fully expected to fall hard. In the first year, CAPS' lowest-rated stocks dropped an average of 16.6%.

Did CAPS call the fall?
In February, for instance, CAPS player 5000monkey highlighted the horrors surrounding Fannie and Freddie:

The worst is yet to come. ... What people fail to realize is that there were more 2 year notes written in '06 than '05, and there are quite a few 3 year notes coming due soon ... With the government also increasing the conforming loan limits substantially Fannie and [Freddie Mac (NYSE:FRE)] are going to be buying up a lot of very large notes (read that more risk) in the next few months. The worst is yet to come.

Just as 5000monkey had warned, Fannie and Freddie continued their free fall last Friday on further worries that the two mortgage giants would need to be bailed out by the U.S. government if their funding problems worsen -- essentially making the shares worthless. With today's news, that bailout seems to be happening, but how much will be needed -- and will it be enough?

The bearish takeaway?
There's really no substitute for knowing a business model cold. As CAPS' 5000monkey demonstrates, by understanding exactly how a company works and the many problems it faces, you can prevent yourself from using fuzzy, surface-level arguments like "too big to fail" or "due for a bounce" when analyzing a stock. Like Warren Buffett simply says, "Risk comes from not knowing what you're doing."

The final Foolish move
Investors often focus strictly on stock price movements, without realizing that developing a proper stock-picking process counts most.

Over at Motley Fool CAPS, thousands of investors are Foolishly sharing insightful investment tips to help, above all else, identify tomorrow's big movers. Over time, consistently reverse-engineering winning -- and losing -- stocks will help you become a more Foolish investor.

Log in to CAPS today and start participating. It's absolutely free -- and a lot of fun!