5 Cold Stocks Heating Up

When a stock's share price is lower than the mercury in a North Dakota thermometer in February, investors tend to give it the cold shoulder. But as the market warms to a stock's prospects, its price can heat up in a hurry. Alas, you can rarely tell when a stock is melting investors' hearts until after it has made that leap up.

Taking the market's temperature
But Motley Fool CAPS' proprietary ratings, aggregated from the opinions and accuracy of 135,000-plus members, offer a great way to monitor investor sentiment. Following a CAPS rating trend can help us determine the best time to invest. Let's look at previously rated one- or two-star companies that have recently enjoyed a bump in investor confidence and see whether they're truly heating up -- or headed back to the deep freeze.

Source: Motley Fool CAPS.

Obviously, this is not a list of stocks to buy -- just a starting point for further research. Yet if some of the best investors in CAPS are taking notice of these stocks, maybe we should, too.

The sun's always shining somewhere
It remains to be seen whether the emails among the Federal Reserve, Treasury, and their lawyers amount to a smoking gun showing that they pressured Bank of America and its CEO Ken Lewis to complete the takeover of Merrill Lynch. Regardless, some analysts are viewing the purchase as the driver that will ultimately take the banking giant higher.

Rather than becoming Lewis's folly, Merrill Lynch -- and even Countrywide -- may yet be seen as the shrewdest maneuver ever, even if Lewis ends up not being around to see it.

One Morgan Stanley analyst suggests that mortgage fees and the investment banking business are starting to pay off and that they'll contribute to significant earnings numbers next year. The analyst estimates that earnings will more than double the high-end estimate already being presented. Throw in a few catalysts, like a market upturn that would push home prices higher -- allowing Bank of America to unload real estate that it has already marked down significantly -- and the impact on the bottom line could be profound. Heck, the company could even pay back its TARP money, just like JPMorgan Chase (NYSE:JPM), US Bancorp (NYSE:USB), and some of the other banks.

Ever the master of understatement, Mad Money host Jim Cramer suggests Bank of America could be "the most compelling buy in the whole stock market today." As good as all that sounds, I'd suggest investors step back and look at what's happening in the mortgage market.

We saw the havoc that the trillion-dollar subprime mortgage industry wreaked on the market, but the chickens that haven't yet come home to roost are the prime, Alt-A, and option ARM mortgages. That disaster waiting to happen will play out over the next few years as teaser rates begin to reset and unemployment worsens. According to value investing guru and hedge fund manager Whitney Tilson, Alt-A and option ARM mortgages are together valued at about $1.5 trillion, and defaults on option ARMs could run as high as 70%. Tilson says borrowers are already defaulting on those option ARMs, even though they are still paying just the teaser rates. When those rates are inevitably reset higher, the bottom could be blown out and the market could tumble much further.

Some analysts are suggesting a peak-to-trough decline in home values of around 40%. With an estimated decline of 30% so far, the floor may still be a ways below us -- and the housing market may not achieve the V-shaped recovery that so many seem to be hoping for.

Investors are also split on what all of this means for Bank of America. CAPS member ArchCap takes the view that the acquisitions the bank made will pay dividends:

In the year [2005] if you add the [earnings] of 1) Bank of America 2) Countrywide Financial and 3) Merrill Lynch when they were all individual companies they made more money than exxon mobil. In excess of 40 billion. This is going nowhere but up. I bought it at 3.88.

But Veneratio is looking for other shoes to drop, such as a possible collapse of the commercial mortgage market.

BAC has been BAD.

I think the rally took off a bit too soon on [Bank of America]. They seem to be the consensus "going to get creamed by commercial-shoe-droppings" bank.

I think its a safe short, with an opportunity for titanic-quality gains if the commercial real estate jihad gets under way.

Shine your starlight
So are these stocks driving ahead or ready to crash? It pays to start your research on these stocks on Motley Fool CAPS. Read a company's financial reports, scrutinize key data and charts, and examine the comments your fellow investors have made -- all from a stock's CAPS page. Then weigh in with your own thoughts on which stocks you think are shooting stars or supernovas. Because it's free to sign up and post your thoughts, why not use this opportunity to take your star turn?.