Wall Street’s 10 Favorite Stocks Right Now

Spooked by 2008's market plunge and some seriously ugly macroeconomic news, investors withdrew more than $55 billion from their mutual funds in just the first three months of 2009. But by year's end, they'd turned around and dumped some $30 billion back in. Things are confusing out there, and investors are (understandably) freaking out about what they should be doing right now.

All that pressure got you down ...
When Wall Street's all sunshine and roses, everyone is a stock market genius. Only during the uncertain times do most investors seek "expert" advice. That often means pulling up Yahoo! Finance to see what analysts think of their stocks.

Despite my long-standing misgivings about the worthiness of Wall Street's advice -- especially now, after a year of watching its business sense nearly destroy our entire economy -- I wanted to find Wall Street's 10 favorite stocks.

So I built a screen using Capital IQ, a great institutional software package. I sought out the stocks with the most analyst "net buy" recommendations, with net buys defined as buys minus sells.

Here they are:

Source: Capital IQ, a division of Standard & Poor's. Includes domestic stocks trading on major exchanges.
*Approximate. Institutional ownership may exceed 100% because of short sales or a lag time in the reporting of institutional holdings.

So what general themes can we gather from this list?

1. For all the criticism that we at The Motley Fool aim at Wall Street for its susceptibility to deadly value traps, its knack for chronically unhinged earnings estimates, and its proclivity to overvalue stocks, I was pleasantly surprised to see so many strong names on the list. Equinix’s scale provides a competitive advantage, and Apple and Electronic Arts have strong brands.
2. Seven of Wall Street's 10 favorite stocks hail from the IT sector. IBM (NYSE: IBM), Dell (Nasdaq: DELL), and salesforce.com (Nasdaq: CRM) – three leading tech companies that benefit from switching costs, operational efficiency, and network effects, respectively – also ranked very highly. We could read this as an informed endorsement that technology will lead the recovery. Or it could just mean that even during recessions, Wall Street can't help getting wrapped up in its enthusiasm for exciting growth industries.
3. Almost by definition, most of Wall Street's favorite stocks are widely followed, widely owned, large, prominent companies. Twenty-nine analysts cover these stocks on average; nearly all have heavy institutional ownership, and most are large caps valued at more than $10 billion.

While many of them could turn out to be great investments, do any of Wall Street's 10 favorite stocks have what it takes to be among the market's 10 best-performing stocks?

Let's find out
To answer that question, let's compare Wall Street's best buy list with the past decade's 10 best-performing stocks.

For each of the past four years, Tim Hanson, former microcap analyst at Motley Fool Hidden Gems, has published his findings on the market's best-performing stocks. Here is his most recent data:

Source: Capital IQ.

What characteristics do the market's top 10 stocks have in common?

They certainly don't belong to a common industry -- Hansen Natural makes natural fruit juice and energy drinks, Terra Nitrogen makes fertilizer, sales of Medifast’s diet food are accelerating in a tough economy, and Southwestern Energy searches for natural gas. These are about as varied and as seemingly random a collection of companies as you could hope to find.

But the 10 best-performing stocks did share three special things in common before they made their incredible runs. They were:

1. Ignored.
2. Obscure.
3. Small.

While many of the stocks on Wall Street's top 10 list may be excellent choices, they don't appear to share the three qualities that seem so crucial to stellar performance.

Stocks possessing these traits not only have more opportunities for growth, but also attract less coverage from Wall Street -- meaning they're more likely to be mispriced. Ironically, these very qualities make it nearly impossible for any of the best-performing stocks to rank among Wall Street's favorites!

And as I've shown in a previous column, those attributes are especially attractive today, when select stocks are cheap. According to data I compiled from Ibbotson Associates, a leading authority on investing research, small stocks outperformed large stocks over the past 13 recessions by an average of 4 percentage points annually!

Small is good
Wall Street's 10 favorite stocks may turn out to be great investments, but it's highly unlikely that any company that attracts so much attention will be one of the top 10 stocks of the next decade. If you want to buy the best returns the market has to offer, you have to be willing to look where others aren't.

Our team at Hidden Gems looks exclusively for promising stocks that are too small to find their way onto Wall Street's radar. They may not be the most recommended stocks, but that's exactly the point. If you're looking for some more ideas, click here to read all about our favorite small-cap bargains, free for the next 30 days.

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This article was first published April 3, 2009. It has been updated.

Ilan Moscovitz owns shares of Hansen Natural and Apple. Activision, Electronic Arts, and Apple are Stock Advisor recommendations. Hansen Natural, Green Mountain Coffee Roasters, and salesforce.com are Rule Breakers picks. Wal-Mart is an Inside Value selection. Motley Fool Options has recommended a synthetic long position on Activision Blizzard. The Fool owns shares of Activision and XTO Energy and has a disclosure policy.