Tuesday's Biggest Stock Stars

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

Without further ado:

There's a reason why I selected notable five-star gainers, as opposed to other big-name winners making noise on Tuesday, like low-rated Sprint Nextel (NYSE:S). Stocks go up all the time, but unless you were able to predict the pop, what does it matter?  

Our community of more than 115,000 CAPS Fools considers its five-star stocks the most likely to outperform the market. And so far, CAPS has indeed proved its market-beating prowess: Since its inception in 2006, five-star stocks are beating the market by 12 points, annualized.

Written in the (five) stars?
For example, just eight of the 226 CAPS All-Stars who've rated Motley Fool Rule Breakers pick Shanda Interactive have a bearish opinion of the stock.

Two weeks ago, CAPS member Watch375k created a helpful list of the stock's positive points. Here's an excerpt:

4) The company is extremely capital light, not requiring large amounts of capital reinvestment to continue operations.

5) The capital light business model results in an enormous ROIC of over 50% meaning continued cash generation.

6) The company currently trades at just over 12 times free cash flow, providing a good margin of safety.

7) Shanda provides gaming entertainment which will become increasingly popular among the biggest population as the middle-class continues to expand. The company continues to expand into the on-line content business (books, etc.)

With the help of yesterday's gain, Shanda Interactive is up a respectable 13% since that call.

The bullish lesson?
There's no better way to find high-quality stocks than to screen for companies with outsized returns on capital. As CAPS' Watch375k understands, businesses exist for one basic purpose: to take money from investors and earn a return on it. In Warren Buffett's words, "The best business to own is one that -- over an extended period -- can employ large amounts of incremental capital at very high rates of return."

And now for the losers ...
Of course, winning isn't everything in the stock market.

Here are five of Tuesday's biggest one-star decliners:  

While yesterday's drop in five-star stock Vale (NYSE:RIO) may have caught our community off guard, one-star stocks are fully expected to fall hard: Since CAPS started, one-star stocks have dropped an average of 11.4%, annualized.

Did CAPS call the fall?
Three weeks ago, for instance, CAPS member Foolishrand directed some cutting criticism toward the management team at Circuit City Stores:

... They are out of touch with the economy, their shareholders, and what used to be their competition ... This quarter's projected deficit: ($163 million). The stock was firmly at $31 three years ago. The stock recovered slightly from its $1.65 RIP for a dead cat bounce up to $1.90, then back down. The company grosses $11 billion, and rents everything including its headquarters. Management is unconcerned.

As if in direct response to Foolishrand's not-so-flattering comments, embattled CEO Philip Schoonover finally stepped down late Monday to appease relentless shareholder calls for his removal.

The bearish takeaway?
The quality of a company's management can often predict how well it will perform as an investment. One of the most overlooked aspects of investing is identifying a competent management team who are actually in tune with the competitive environment around them. As renowned value investor Bruce Berkowitz said in a recent interview, "A bad person can cause you pain every time, no matter how good the company is. Management is important. They should have a paper trail of succeeding."

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!