Tuesday's Biggest Stock Stars

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

Without further ado:

The reason I selected the largest five-star gainers, as opposed to other big-name winners making noise on Tuesday -- such as tech stocks Apple (NASDAQ:AAPL) and Research In Motion -- is simple: Stocks go up all the time, but unless you were able predict the pop, what does it matter?    

Our community of more than 74,000 Fools in CAPS considers its five-star stocks the ones most likely to outperform the market.

Written in the (five) stars?
China Fire & Security Group, for example, has been a long time micro-capped favorite of our community, maintaining a five-star rating for more than six months straight. So far, of the 253 All-Stars who've rated the Beijing-based provider of fire safety products, a measly three of them are bears.

This outperform pitch -- by CAPS All-Star phonixed late last August -- taught Fools a valuable valuation lesson:

It looks like I am a little late on the CFSG train, but due to the research, this is one stock that is poised to reach [$13] in a matter of a few short months (6-8 months to price target). ...

The year's earnings are expected to be [$0.53]/share compared to [$0.30]/share simply a year ago. Their last quarter accounted for nearly half that jump at [$0.14]/share.

Compared to their earnings growth rate of 37 percent, the stock is cheap and will be cheap well into the middle of next year making it a buy on the fundamental front.

China Fire has returned 88% since that call and is up a whopping 278% year over year -- even better than phonixed had figured. In fact, yesterday's pop came after management reported better-than-expected third-quarter results and announced increased earnings guidance for fiscal 2007.

The bullish takeaway? Never underestimate the power of strong earnings momentum -- especially if the growth is cheap. Oftentimes, Wall Street remains anchored to a specific set of estimates and fails to fully discount a company's true growth potential. It may take some work to dig up, but buying into reasonably priced, rapidly growing small caps is a surefire way to outperform. 

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

Here are Tuesday's biggest one-star decliners:   

One-star stocks inspire the least confidence from our CAPS players. So, while Tuesday's drop in four-star Hansen Medical (NASDAQ:HNSN) may have caught our community off guard, CAPS investors expect it bounce back. Unlike one-star stocks that are fully expected to fall -- and fall hard.

Did CAPS call the fall?
Take, for instance, this WorldSpace underperform excerpt by CAPS All-Star rd80 in mid-July:

If the estimates turn out to be correct, WRSP will have used up all their cash about the end of '08 and will need to either borrow more money, issue more shares or go under. So, they've got about a year to fix the business model and demonstrate some progress on the path to profitability.

The financials to date indicate they're very successful at burning cash, not so good at making it.

The Maryland-based provider of satellite-based digital radio services has fallen 31% since that call. In fact, the stock has been falling since Thursday, when management reported a third-quarter earnings and EBITDA loss of $36.7 million and $20.3 million, respectively -- consistent with rd80's observations.

The bearish lesson? Cash is king! After all, cash is the lifeblood of any business, and without it, a company can survive for only so long. Of course, management can always raise more cash by issuing shares (dilution) or taking on more debt (increasing bankruptcy risk), but none of those actions really builds shareholder wealth. If done excessively, they're actually certain to destroy it.

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

Over at Motley Fool CAPS, thousands of investors Foolishly share insightful investment tips to help 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!