3 Underdog Stocks We're Watching Closely

By Tyler Crowe, Jordan Wathen, and Beth McKenna Markets Fool.com

America loves its underdog stories. Whether it's some unknown rising to prominence or a big name on the comeback trail after a fall from grace, there is always that desire to see those kinds of stories succeed over the long term.

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So we asked three of our contributors to highlight a stock they see as a real underdog in the market today and why investors should be watching this stock. Here's a quick look into why they picked banker Wells Fargo (NYSE: WFC), railcar manufacturer Greenbrier Companies (NYSE: GBX) , and egg wholesaler Cal-Maine Foods (NASDAQ: CALM).

Image source: Getty Images.

Banking on the stagecoach

Jordan Wathen(Wells Fargo):Maybe Wells Fargoisn't exactly the kind of stock you'd think of as an underdog, given that it trades near post-crisis highs like most banks. But since its recent accounts scandal, Wells Fargo has broadly lagged the larger banking industry.Some of its sector-lagging performance can be explained by asset sensitivity. It just doesn't have as much to gain from higher interest rates as other banks do. The other part can be explained by a widespread belief that Wells Fargo's fee generators won't be as lucrative as they used to be.

While Wells Fargo may be loved for its ability to generate fee income, its credit record is much better than that of its big-bank peers. In the years that followed the financial crisis, Wells Fargo's net charge-offs peaked at 2.3% of average loans, while Bank of America's reached 3.6%, and JPMorgan's"fortress" balance sheet endured losses equal to 3.4% of its loans.

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Wells Fargo has a long history of adequately provisioning for losses, and running from markets where it sees increasing default risks. As a recent example, its decision to pull back on subprime auto lending in 2015 appears to have been well timed. As long as the aggressive sales processes didn't infect its underwriting or credit processes, it should continue to outperform its big-bank peers by simply being a little smarter about managing its lending risks.

A railroad investment picking up steam

Tyler Crowe (Greenbrier Companies):It's hard to deny the competitive advantages that railroads have over other forms of transportation for moving goods over long distances. The average revenue per ton-mile for moving goods via rail is consistently a small fraction of the cost to move things via truck or rail. This means that there is little chance that freight rail is going to be disrupted anytime soon. That is the underlying idea for investing in railcar manufacturer Greenbrier Companies, but the story is much deeper than that.

Greenbrier has undergone a major transformation over the past several years. What was once a debt-laden company with middling returns on equity now has cleaned up its balance sheet and is churning out strong rates of return. During that time of higher debt, the company was making some large investments to revamp its manufacturing capacity and expand into other types of railcars to meet customer demand. These efforts have led to higher margins and a large backlog of work.

Wall Street doesn't seem to be wise to the changes that have happened at Greenbrier. The company's stock currently trades at an incredibly cheap enterprise value-to-EBITDA ratio of 3.97 times. This stock looks like a real gem of a value at a time when valuations at so many other stocks are getting awfully frothy.

A scrambled stock that has sunny-side-up potential

Beth McKenna(Cal-Maine Foods):One underdog stock I'm watching is that of Cal-Maine Foods, the largest producer and distributor of fresh shell eggs in the United States. The company isn'tan underdog in the sense that it's a small player in its industry, but in the sense that its stock has been struggling, while the broader market has been performing well.

Cal-Maine stock's total return is negative 18.6% for the one-year period through Feb. 9, while the S&P 500 has returned 26.5% over this period. It remains, however, a long-term winner, as the chart below shows. This superior long-term performance reflects the company's sustainablecompetitive advantages and management's ability to execute, in my opinion. So I believe the company and its stock have a good shot at eventually resuming their strong performances.

Data by YCharts.

Cal-Maine's recent stock-price volatility stems from theavian flu outbreak in the U.S. in the spring of 2015. (None of Cal-Maine's flock tested positive for the virus.)The company's year-over-year financial results benefited big-time from the surge in shell egg prices following the outbreak, though naturally suffered when shell egg prices fell back down to Earth. Moreover, export demand declined as a result of the outbreak and still hasn't recovered.

Cal-Maine has a strong balance sheet with just $22.5 million in debt and $197.7 million in cash at the end of the most recently reported quarter. So, unlike many smaller players, it's well equipped to weather the challenging market conditions. Moreover, the company has a huge long-term catalyst for growth: Nearly all major egg buyers, including retailers such asWal-Martand fast-food chains likeMcDonald's,have pledged to buy only eggs laid by cage-free hens by a certain date. As the industry's heavyweight, Cal-Maine has the most resources to ramp up its cage-free egg production capacity, which it has been doing.

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Beth McKenna has no position in any stocks mentioned. Jordan Wathen has no position in any stocks mentioned. Tyler Crowe has no position in any stocks mentioned. The Motley Fool recommends The Greenbrier Companies. The Motley Fool has a disclosure policy.