Wall Street analysts are paid to stay ahead of stocks, which is why investors should pay special attention to an important one-two combo: stocks that are outperforming the market, but that also have low analyst recommendations.
The theory is simple: Regardless of the amount of knowledge and data available to the analyst community, we still see signs that herd mentality tends to drive upgrades and downgrades. As a result, we sometimes find hot stocks rated “sell” that should be in Wall Street’s “buy” column.
Thing is, the longer an underrated stock outperforms the market, the more likely that analysts are to catch on and begin upgrading. Then herd mentality takes over, as one upgrade usually leads to a stampede as the rest of the Street realizes that they’re on the wrong side of the trade.
Currently, two underloved outperformers in the S&P 500 — Dr Pepper Snapple Group (DPS) and Dow Chemical (DOW) — look like hot stocks to buy, as both are candidates for upgrades over the next few months as they continue to leave the market behind with strong price performance.
Hot Stocks to Buy: Dr Pepper Snapple Group (DPS)
Seemingly lost in the two company battle between Coco-Cola (KO) and PepsiCo (PEP), DPS stock has been shunned by the analyst community, despite blowing both of the companies out of the water in terms of performance year-to-date.
Click to Enlarge Namely, 82% of the analysts covering DPS stock have missed a 17% surge in share prices as the stock is breaking through to new all-time highs. The price pressure alone is likely to shake some of the “holds” into the “buy” category, fueling even more buying of the shares.
In addition to the low analyst ratings, DPS stock also is among some of the most heavily shorted names on the S&P 500 with a short interest ratio of 5.8. While that seems like a bearish indicator, we view the high short interest is a sign of a healthy “wall of worry” for DPS to continue climbing.
Hot Stocks to Buy: Dow Chemical (DOW)
Click to Enlarge Chemical giant Dow has had a great year, posting a year-to-date return of almost 20% and outpacing the rest of the market. But you wouldn’t know it from looking at the current analyst ratings, which show only 39% of the opinions in the “buy” category.
However, DOW stock is rated a “technical buy” by our proprietary rating system, which measures technical strength of a stock’s rally.
DOW stock has spent the last two months consolidating just below $50. While much of the market has declined, this nap should help DOW move to the next level.
Chemical and basic material companies will continue to pass the rest of the market in the performance column, meaning that the analysts that have been holding out on upgrading Dow stock will have to start moving their opinions to avoid being even more wrong.
As of this writing, Johnson Research Group did not hold a position in any of the aforementioned securities.