Investment Strategies: For Market-Beating Profits, Here Are Three Stocks That Aren't on Wall Street's Radar Screen

When I was an analyst at the uber-contrarian Avalon Research Group, we only initiated coverage on a stock if our opinion went against the consensus, or if the security was barely (or not at all) followed by Wall Street.

For this column, I'm going to focus on the latter - and show you how this seemingly unconventional investment strategy can actually make you a lot of money.

If you want quantifiable proof, consider this nice bit of research from Cem Demiroglu at Koc University in Turkey, and Michael Ryngaert at the University of Florida: In 2008, they conducted a study that showed that stocks without any analyst coverage experienced a 4.82% higher return than their peers after coverage initiation.

The lesson here is simple.

Invest Ahead of the Wall Street Herd

Owning stocks that Wall Street doesn't follow is usually a sure-fire way of getting in before the crowds.

Stocks that lack Wall Street's sponsorship in the form of analyst coverage are known as "orphan stocks." And there's a big advantage to owning these orphan shares.

When you buy stocks before analysts cover them, there usually aren't many institutional owners. But once firms like Goldman Sachs Group Inc. (NYSE: GS) and Morgan Stanley (NYSE: MS) start recommending them to their hedge- and mutual-fund clients, it often triggers new and heavy demand for the shares.

Plus, just having a new "Buy" rating flash across the news ticker can often be enough to move a stock higher all by itself.

When talking about neglected stocks, Greg Forsythe, senior vice president of Equity Model Development for The Charles Schwab Corp. (Nasdaq: SCHW), explained it the best when he said: "Explorers seeking new lands don't look where others have already been."

Two China Stocks Wall Street Has Yet to Discover

So let's explore some stock territory that Wall Street hasn't yet discovered...

  • Telestone Technologies Corp. (Nasdaq: TSTC): Based in Beijing, this mobile-telecom-equipment provider hasn't attracted the attention of any Wall Street analysts so far. However, analysts are likely to zero in on the stock's Price/Earnings (P/E) ratio of 14 and healthy balance sheet, and will initiate coverage after that. The company's fourth-quarter revenue should be very strong. Its current forecast is for $70 million in sales for the full year, double the total from 2008. If it's able to achieve that $70 million target, you could see earnings pop and the P/E drop to 12.
  • QKL Stores Inc. (Nasdaq: QKLS): Staying with our China thesis, we turn to supermarket player QKL Stores. Only one analyst - at Roth Capital Partners LLC - follows the firm. And he currently has a "Buy" rating on the stock, which is currently trading at 15 times earnings. If Roth's earnings-per-share (EPS) estimate of 45 cents per share for 2010 is correct (a 28% jump from expected 2009 earnings), the stock would trade at just 13 times its forward earnings. It also trades at less than six times its trailing 12 months' cash flow. QKL has no debt. Once other analysts start looking for profitable businesses in China, and see how cheap this stock is, you'll likely see more jump on the bandwagon. And that should lift the share price higher.

Where the Heck is Solon?

Here's another neglected stock for your consideration...

  • Agilysys Inc. (Nasdaq: AGYS): Wall Street obviously missed the exit for Solon, Ohio. Just two analysts cover information-technology player, Agilysys. Perhaps the company's projected EPS of only nine cents for fiscal 2010 (which ends in March) deters them. But it's no surprise that Agilysys got hit hard during the economic downturn. Hospitality companies and retailers cut back their IT spending in a big way. Despite the sour economy, however, the company was able to generate a ton of cash - $81 million in cash flow from operations over the past 12 months, to be exact. That makes the stock very inexpensive, at just 2.6 times cash flow. And despite weak earnings in fiscal 2010, the firm's per-share earnings are expected to climb - all the way to 83 cents in fiscal 2011. According to the two analysts that cover the stock, earnings are projected to grow at an average annual clip of 15% over the next five years. So if things improve in 2010, Agilysys could be a cash-generating machine. Those kinds of numbers will make it tough to ignore this stock.

Investing in Wall Street's Stock Oversights

To get in while the gettin's good, you often need to buy stocks before you hear about them from analysts. As a quick guide, look for companies that have healthy balance sheets, trade at reasonable valuations, and aren't receiving much attention from Wall Street.

Follow this formula and you're likely to outperform many of those Wharton MBA types who crunch numbers into their spreadsheets for 15 hours a day, trying to figure what out Apple Inc.'s (Nasdaq: AAPL) revenue will be. View their neglect as your call to action - and use it to your advantage.

[Editor's Note: Healthcare and biotech expert Marc Lichtenfeld is the director of research for the Access Research Group. He's also the resident healthcare specialist for White Cap Research and The White Cap Report's mid-month issue, The Xcelerated Profits Report.

To keep tabs on all Lichtenfeld's latest stock recommendations, hook yourself up with a risk-free trial membership to The White Cap Report. In it, Lichtenfeld analyzes the most promising small-cap stocks and uses his expertise in the healthcare and biotech sectors to identify the companies with potential breakthrough, blockbuster drugs. For more details, please click here.]

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