Get Ready for the Fall

"The bigger they are, the harder they fall." It's the worst nightmare of every investor in today's market -- buying a hot stock just before it takes a nosedive.

Every day, MSN Money publishes a list of stocks whose shares have just hit new 52-week highs. And every day, investors read the list and tremble -- some with greed, others with terror. On our Motley Fool CAPS investing community, these top stocks usually enjoy favorable ratings, since everyone loves a winner. But what should you do when some of CAPS' smartest investors pan one of these hot stocks?

For starters, consider using the "52 week high" list as a starting point for further research. Stocks can rise for many reasons, but a little help from Motley Fool CAPS can make it easier to figure out how worthy those reasons are. Let's see what the more than 93,000 stock gurus (and counting) in CAPS have to say about the list's latest contenders:

One Year Ago Today

Currently Fetching

CAPS Rating (5 max):

Gushan Environmental Energy  (NYSE:GU)

$9.73*

$15.05

****

Pengrowth Energy Trust  (NYSE:PGH)

$16.87

$19.16

****

Clayton Williams Energy (NASDAQ:CWEI)

$28.37

$47.27

****

Quaker Chemical  (NYSE:KWR)

$23.81

$28.54

****

Possis Medical  (NASDAQ:POSS)

$13.01

$19.50

*

*Gushan Environmental Energy began trading on Dec. 19, 2007.
Five stars = highest possible CAPS rating; one star = lowest. Companies are selected from the "New 52-Week High" list published on MSN Money on the Saturday following close of trading last week. One year ago and current pricing provided by Yahoo! Finance. CAPS ratings from Motley Fool CAPS.

Everybody loves a winner
When stocks soar on the wings of success, bears become rare. Nearly every one of the stocks on today's list, in addition to hitting its 52-week high, rates highly in the estimation of CAPS investors. Every stock but one, that is: Possis Medical, due to be acquired by Bayer.

Um ...
So hold up a sec. If Bayer wants to buy Possis for $19.50 per share, Possis shares are already trading at $19.50, and Possis shareholders have already approved the sell-out by a 92% margin, then how, pray tell, is Possis supposed to underperform the market, as CAPS investors seem to think? There's something funny going on here, Fools. Let's see whether the people who rated Possis an underperformer in the first place can shed any light on ...

The bear case against Possis Medical
Three investors have posted their thoughts on Possis since the merger news broke on Feb. 11. Here's what they have to say:

  • A couple of weeks back, JonAtkins57 wrote: "P/E * EPS > Last Trade by ~$1.75." Points for being enigmatic, but this pitch hardly explains the mystery. Let's try again.
  • CAPS All-Star ReInAd objects to the valuation, observing last month that: "POSS is trading at a price to earnings ratio of nearly 500. Selling at 4 times book value and is technically overbought."
  • And if JonAtkins57 gets points for enigma, then we have to give 3DeeFool similar points for honesty, writing: "Just jumping along on this one."

At the risk of reading between the lines, I have to say that these pitches all "feel" like the authors were unaware of the fact that Possis was due to be purchased at a set price of $19.50 per share, and so made uninformed "underperform" calls. But there are two alternative reasons why Possis might be marked down:

First, a company about to disappear has little time to outperform the market. It's a bit late in the game for a rival to appear and trump Bayer's offer. My best guess is that investors think the broader market will rebound soon, exceeding Possis' performance between now and the closing of the deal.

Second, there's always the risk that even though Possis shareholders approved Bayer's offer, it could still fall through. Shareholder approval of Bain Capital's buyout of Clear Channel (NYSE: CCU  ) , isn't preventing that deal from falling apart as we speak. Past "sure things," such as buyouts of Sallie Mae (NYSE: SLM  ) , United Rentals, and Harman, are all dead as doorstops. Perhaps investors fear something similar will happen to Bayer's buyout of Possis.

Foolish takeaway
For the record, I think both these scenarios are flawed. The market turmoil initiated by the housing crisis is far from over. Until some clarity develops on that front, I see little chance of a broad-market rebound that would leave Possis stock in the dust. As for Bayer's buyout falling apart -- there's a big difference between private equity funds promising to load up on debt to fund a buyout (and then getting stiffed by their bankers), and an industrial giant like Bayer, with $3.7 billion cash in its pocket, offering to spend less than one-tenth of that to buy a promising subsidiary. I don't see Bayer having any financing problems here.

Long story short, you shouldn't short Possis. This deal is going through.

Disagree? Feel free. Click over to CAPS and tell us why Possis deserves its stock symbol.


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