These Underdogs Are No Dogs

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Short-sellers and hedge funds may be shadowy, but sometimes they are the smartest guys in the room. They've done their homework, and they're willing to bet their capital against the crowd -- an investing strategy that can be as lucrative as it is contrarian.

On Motley Fool CAPS, we've also got leading analysts who find the chinks in a company's armor and correctly call its fall. Our "Underdogs" have earned 100 or more CAPS points by correctly predicting that one or more stocks would underperform the market. However, we're going to focus on the stocks these top members expect will outperform the market. If these CAPS investors have scored big by correctly predicting which stocks will fail, it may be worth our while to see which others they think will succeed.

Underdog

Member Rating

Company

CAPS Rating (out of 5)

stampsc98.87Annaly Capital (NYS: NLY) ****
genedom96.82VIVUS (NAS: VVUS) **

Source: Motley Fool CAPS.


Not every short sale goes as planned, making shorting a risky proposition. Stock prices can be irrational longer than you have money to stay in the game. So don't use this as a list of stocks to sell or buy -- just the launching pad for further research.

A capital opportunity?
The big near-term risk for mortgage REITs such as Annaly Capital, CYS Investments (NYS: CYS) , and ARMOUR Residential REIT (NYS: ARR) is the effect that narrowing interest rate spreads could have on their business models. Like many of their brethren, these mREITs have cut their dividends, and further cuts could endanger investor confidence, as many who choose to put their money with the REITs do so for the juicy yields (the three above have a combined average yield of more than 15%).

The housing market remains sick as Mortgage Bankers Association application data confirm applications are still falling. Ignoring the higher refi numbers, which would probably work against the mREITs, new applications slammed 11% lower in the current week and are 13% lower than the year-ago period. The landscape is changing for the worse, and fewer investment opportunities will become available for the REITs. They benefit from mortgage volume, particularly as new securitizations of agency-guaranteed residential-mortgage-backed securities provide opportunities for portfolio reinvestment.

I've rated Annaly to underperform the markets on CAPS for the above reasons, a view similarly shared by Sophos2: "easy bet, with these dividends it will have a hard time beating the S&P long term. Also, they are diluting with share issues and low rates will end someday and it will hurt them."

It's not a popular position to stake out, but combined with disastrous Federal Reserve policies, I maintain it's the right one. Add Annaly Capital to your watchlist and let us know in the comments section below whether the mREIT will merit your attention.

A bubble ready to pop?
Fat fighter Arena Pharmaceuticals (NAS: ARNA) has a date with destiny next month as the FDA advisory panel considers lorcaserin with a full agency decision in June. Investors who had been watching the regulatory body's actions on VIVUS' Qnexa have to be feeling a bit of trepidation now that the FDA has delayed for three months its decision to give it time to review the Risk Evaluation and Mitigation Strategy plan VIVUS submitted. Lorcaserin has much more uncertainty surrounding it than Qnexa.

But as the Fool's biotech guru Brian Orelli notes, if the REMS is the FDA's only concern then VIVUS probably has approval in the bag... but that doesn't make the stock a buy at this point.

VIVUS has shot up to a $2 billion market cap, much higher than it was before the FDA made its first decision in 2010. There's room to go higher if you assume Qnexa shouldn't have too much trouble becoming a blockbuster in a few years, but the risk isn't zero and there's a lot of room to fall if the FDA makes a surprise rejection.

I agree with his assessment to a certain extent, partly because after the run-up much of its success has already been priced into the stock. And should the FDA surprise once again and reject Qnexa, the drop in the stock's value will be stomach-churning to say the least. Seems all the benefit has been priced in and there's only downside risk facing it.

CAPS member yandar sees products getting warning labels all the time and thinks Qnexa will be one of those that is slapped with one, too. Add VIVUS to the Fool's free portfolio tracker and tell us on the VIVUS CAPS page which way it's shares are likely to go.

There's no need to fear...
Underdogs often shine brightest with their backs against the wall, but with solid dividend-paying stocks your retirement portfolio doesn't have to be under the gun. Check out the best dividend payers the Motley Fool can find in its free report "Secure Your Future With 9 Rock-Solid Dividend Stocks." There's not a dog among them, so get your copy today by clicking here.

At the time this article was published Fool contributor Rich Duprey holds no position in any company mentioned. Click here to see his holdings and a short bio. The Motley Fool owns shares of Annaly Capital Management. Motley Fool newsletter services have recommended buying shares of Annaly Capital Management. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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