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, The Wall Street Journal 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 115,000 stock gurus (and counting) in CAPS have to say about the list's latest contenders:

Five stars = highest possible CAPS rating; one star = lowest. Companies are selected from the "New Highs & Lows" lists published on WSJ.com on Thursday and Friday last week. One-year-ago and recent prices 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. Particularly in a market like this one, I'm not surprised to see that most of the stocks holding their own -- and even soaring -- enjoy widespread appeal among the investing public.

And then there's Foot Locker.

This retailer of all things sporting and shoe-worthy -- from Crocs (Nasdaq: CROX) to Reeboks, Under Armour (NYSE: UA) to Nike (NYSE: NKE) -- has been on an absolute tear the past few months. It's risen more than 40% from its July lows and briefly passed $18 on Thursday. So why do Fools hate it? We're about to find out, as we walk a mile (figuratively speaking) in the shoes of Foot Locker bears.

The bear case against Foot Locker
NetscribeRetail sketched out the bear case for us last year:

The growth story of Footlocker (FL) seems to have come to a halt in the rewarding footwear industry. The mall-based athletic retailer with operations worldwide is facing resistance in pushing its sales in the past few years. Owing to the cutthroat competition, company has experienced decline in its store-traffic levels, which has especially paralyzed its athletic offerings.

Indeed, last quarter, Foot Locker barely managed to grow its sales 1%. 

Not that it's all Foot Locker's fault. WPThatcher summed up another reason to avoid the stock in just two words back in March: "Slowing economy." Meanwhile, celticspirit concludes, "At this sort of price valuation Foot Locker is destined to disappoint the market and then down she blows."

That all adds up to a pretty easy-to-understand bear thesis: Foot Locker is expensive. Its sales are slowing. A sluggish economy could slow business down even further. But do the numbers back up this tale of woe?

As I already mentioned, the sales slowdown seems clear. The economy -- well, you know how that's going, too. And that leaves us just Foot Locker's valuation to examine. At first glance, I'm inclined to agree with celticspirit -- Foot Locker does look expensive.

I mean, is it really reasonable, on the cusp of a recession, to pay 36 times earnings for a retailer? American Eagle (NYSE: AEO) stock costs only a small fraction of that. "Expensive" Aeropostale (NYSE: ARO) can be had for half Foot Locker's multiple and is growing more rapidly than the 14% long-term pace analysts expect Foot Locker to achieve.

Second glance
But on closer examination, I think the bulls may have the better of this argument. Sure, from a price-to-earnings perspective, Foot Locker seems insanely overpriced. But look past the GAAP numbers, and you soon realize that Foot Locker is churning out the cash. This company hasn't had a free cash flow-negative year since the calendar kicked over to the 2s. Over the past 12 months, Foot Locker generated a whopping $245 million in cash profit.

Factor this into your analysis, and the company sells for an enterprise value-to-free cash flow ratio of less than 10 -- which seems more than reasonable based on the growth rate. Long story short, I have to take issue with the bears today. I'm not convinced that Foot Locker is headed for a fall.

Time to chime in
Of course, the aim of this column isn't just to tell you what I think about Foot Locker -- or even what other CAPS players are saying. We really want to hear your thoughts. Click on over to Motley Fool CAPS and tell us what you think.

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