Some of the best investment ideas come from places where few people are looking. This is especially true for stocks that underfollowed or unloved by stock analysts.
Underfollowed stocks have little or no analyst coverage. Unloved stocks are covered by analysts who rate the stock Hold or Sell. Thus, underfollowed and unloved stocks are covered by a few analysts who don’t have Buy ratings on those stocks. As a result, these stocks have no one touting their growth story, potential turnaround or cheap valuation.
Moreover, brokers are cutting back on research staffs, leaving more stocks with fewer analysts to cover them -- or they go without Wall Street coverage altogether. And that is where the opportunity lies: those orphaned stocks with solid upside potential. It just takes a little work to find good ideas.
Patience, Patience, Patience
Of course, targeting this type of stock requires patience. Unless you are really lucky with your timing, investors should not buy these stocks with the idea of selling in a few days or weeks. It will take some time for the market to recognize these relatively unknown stocks.
But once these stocks are discovered, the stock prices can quickly move higher. This could come from broker upgrades. An analyst changes her rating to Buy and starts selling the idea to institutional clients. If the institutions like the idea, they will begin to snap up shares and push the stock higher.
Another possibility is that the company is acquired at a large premium by a larger company or private equity firm. In either case, if you wait for confirmation from the market about the stock, it will be too late to buy it.
These stocks are small, tend to be illiquid, and/or the stories may not turn out as planned. With the higher risks come higher rewards. To mitigate some of the risk, it is a good idea to look for a margin of safety when buying. In other words, focus on stocks with cheaper price tags to avoid overpaying.
That said, if you are willing to do a little research, these underfollowed and unloved stocks could deliver market-beating returns.
Where to Begin?
A good place to start is with Zacks Investment Research, which can help retail investors find undiscovered stocks. Using the Zacks Research Wizard, I screened for Zacks #1 Rank stocks with no analyst Buy ratings. That screen produced about 20 names. From there, I dug a little deeper to identify three names that should offer solid upside potential.
Here are three underfollowed and unloved stocks with a Zacks #1 Rank and no Buy ratings.
Ashford Hospitality Trust (AHT - Snapshot Report)
Ashford Hospitality Trust, a real estate investment trust (REIT), invests in the hospitality industry primarily in the U.S. The company invests in various segments and at various levels of the capital structure, including direct hotel investments, first mortgages, mezzanine loans, construction loans and sale-leaseback transactions.
For the first quarter, Ashford reported $0.32 per share, topping the Zacks Consensus by 8 cents, or 33.33%. In the last two quarters, Ashford has beaten the Zacks Consensus by an average of 21.8%.
In the last 60 days, the Zacks Consensus Estimate for 2010 is up 13 cents, or 12.8%, to $1.15, and the Zacks Consensus for 2011 is higher by 24 cents, or 18.2%, to $1.56.
Ashford is trading at 6x 2010 consensus EPS estimates and 4x 2011 consensus estimates.
Innospec Inc. (IOSP - Snapshot Report)
Innospec Inc. engages in the development, manufacture, blending and marketing of fuel additives and other specialty chemicals to oil refineries, and other chemical and industrial companies worldwide.
For the first quarter, Innospec earned $0.67 per share, matching the Zacks Consensus Estimate. In the last month, however, the Zacks Consensus Estimate for 2010 rose 55 cents, or 80.8% and the Zacks Consensus Estimate for 2011 increased 44 cents, or 44.0%.
Innospec shares trade at 8x 2010 consensus EPS estimates and 6x 2011 consensus EPS estimates.
Stepan Company (SCL)
Stepan Company engages in the production and sale of specialty and intermediate chemicals. The company operates in three segments: Surfactants, Polymers, and Specialty Products.
The company had first-quarter EPS of $1.76, easily beating the Zacks Consensus Estimate of $1.32. After its Q1 report, the Zacks Consensus Estimate for 2010 popped 42 cents, or 8.6%, to $5.28, and the Zacks Consensus Estimate for 2011 climbed $1.57, or 30.7%, to $6.69.
Stepan shares trade at 12x 2010 consensus EPS estimates and 10x 2011 consensus EPS estimates.