Rocket Stock or Dud?

By Rich Smith

October 14, 2008

4 Recommendations

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

Every day, WSJ.com 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 just 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 115,000 stock gurus (and counting) in CAPS have to say about these contenders:

	One Year Ago Today	Recent Price	CAPS Rating (5 max):
UltraShort Oil & Gas ProShares (AMEX: DUG)	$38.64	$74.40	*
UltraShort Real Estate ProShares (AMEX: SRS)	$82.80	$113.31	**
UltraShort S&P 500 ProShares	$48.39	$110.88	*
Short S&P 500 ProShares	$57.33	$92.00	*
UltraShort Consumer Services ProShares	$70.68	$157.86	*

Five stars = highest possible CAPS rating; one star = lowest. Companies are selected from the "New Highs & Lows" lists published on WSJ.com on Saturday of last week. One year ago and recent prices provided by Yahoo! Finance for the same date. CAPS ratings from Motley Fool CAPS.

"Everybody loves a winner"
So people say. But this week, winners are rarer than orange groves in Ontario. Just one stock -- one! -- closed at a new 52-week high on Friday: a little microcap jobber by the name of Consulier Engineering.

So how is it that we even have a list of "52-week highs" this week? Because over on the AMEX, at least, they don't just trade stocks, but exchange-traded funds (ETFs) as well. And some of those are soaring. But it won't take you more than a quick skim of the table above to learn that this is not good news. All five of the "stocks" listed above are short bets against various market niches. And what does this tell us?

Investors are shorting oil, shorting land, shorting the S&P -- even shorting the indefatigable American consumer.

Big mistake. Huge.
CAPS members think this is an extremely risky strategy. These ETFs have one thing in common, in that they represent short bets, but they also share below-average, one- and two-star ratings on CAPS. By massive majorities, Fools think it's (small-f) foolish to bet against the U.S. economy bouncing back.

Sure, short term, this strategy seems to be working out. But remember: When you bet on a stock, your profits are potentially limitless. Thanks to the miracle of compounding, $1,000 can grow into $1 million in a matter of just a few decades. In contrast, the best a short bet can ever yield is a 100% gain.

Need more convincing?
Say you had a crystal ball five years ago. Say you knew that over the course of five years, each of General Electric (NYSE: GE), Cisco (Nasdaq: CSCO), eBay (Nasdaq: EBAY), and Citigroup (NYSE: C) was destined to lose value -- and so you shorted them. Want to guess how much money you would have made?

If you shorted $1,000 worth of stock in each, then five years' of pessimism would have netted you a combined profit of $1,400, as GE lost 14% of its value, Cisco fell 18%, eBay lost 43%, and Citi plummeted all of 65% in price.

But what if, on the other hand, rather than shorting these four stocks, you had bought just one great stock back then -- say, Research In Motion (Nasdaq: RIMM)? In that case, RIM's 654% increase in value would have more than quadrupled your take from guessing right on the short side four times in a row.

Foolish takeaway
The bears are hungry these days, and the shorts are rampant. But there's a reason Fools look askance at the short ETFs so popular this week: We know that over the long term, buying great businesses with strong growth prospects is the surest path to profit.

Time to chime in
Of course, the aim of this column isn't just to tell you what I think about investing, ETFs, or shorting. We also want to hear your thoughts. If you think now's the time to bet against the market, come on over to Motley Fool CAPS and tell us why.

What do the unfolding financial crisis and ongoing market volatility mean for your money? The Fool's here with answers. Get the best of our daily commentary and analysis in your inbox simply by entering your email address in the box below.

Fool contributor Rich Smith does not own shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 881 out of more than 115,000 members. eBay is a Motley Fool Stock Advisor recommendation. The Fool's disclosure policy is short to read but long on value.

Comment (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment icon found on every comment.

On October 15, 2008, at 10:17 AM, lemoneater wrote: Report this Comment

Thank you very much for the clear explanation of the profit potential for shorts. As a new investor, I had the vaguest idea of what shorts were and what they could do. Consequently, I have avoided them. Now that I understand that there is no possibility of shorts doubling or quadrupleling one's profits I have fewer regrets about not shorting!
On October 18, 2008, at 8:34 PM, Cedarowl wrote: Report this Comment

Long term, I agree with you. I also agree shorting is a risky business. However, what goes up, especially what has gone up up up, has a very long way to fall. Shorting during the fall can be very profitable.
I've focused on real estate and in particular the stock (UltraShort Real Estate ProShares) . Disclosure, I own this stock. I've done quite well and believe its stock price will continue to rise. WHY?
IMO - The overall market characteristics effecting Real Estate are worse now than they've been in 20 years. It's only now starting to show up in the Commercial Real Estate sector, i.e. OFFICE/CONDO towers. The disaster of the Single Family residential market is already out of the closet and old news. However, Commercial Real Estate's fall is only now starting to be realized and should be in the same proportion as the single family market.
Over the next 2 - 3 years, Commercial Real Estate is going to get hammered hard. REITS have to pay out most of their cash flow. Their stock prices have been tumbling but we have not even come close to seeing the bottom yet. WHY?
Interest rates are higher than in the past, especially when taking into consideration spreads.
Capital availability (loans) are scarce, expensive and very hard to find today.
Supply of new office/condo/apartment continues to increase with properties still coming onto the market which were started over the last year during the froth.
Demand is falling and will continue to fall as companies close, consolidate and layoffs start to grow.
Rents will continue to fall as concessions by Landlords, i.e free rent, tenant improvements, commissions, increase dramatically over the next several years thereby lowering cash flow available for debt service or distribution.
Cap rates( the basis for which properties are valued) have increased dramatically, lowering property values substantially.
All of the above characteristics are negative for real estate. Not one good sign on the horizon
An example, a REIT like Boston Properties is down substantially from its highs (from 122 to 68) so one would think it's taken the hit and reached its stock lows. However, its stock price is still 100% higher now (68) than it was in 2000. (32)
If you conclude, as I have, that the market characteristics are far worse now than at any time over the last 20 years, then REIT stock values still have a long way to fall. The shorts can be a way to make BIG money in the market near term.
On October 18, 2008, at 8:41 PM, jbuckits wrote: Report this Comment

SRS is in a rapidly exploding upward channel. The possibility is clear for 40 percent spikes weekly. As Mervyns files for bankruptcy and Sears flounders like a fish on the beach, the real estate commercial sector is only beginning to show cracks. As the huge "For Sale" signs pop up in every mall the consumers will be afraid... very afraid. Until otherwise proven, the trend remains up in this rollercoaster, and down in retail and real estate. This is not a stock for granny tortoise races, it's a shot down the quarter mile at 200 mph.
On October 29, 2008, at 9:03 AM, luckychuckie1 wrote: Report this Comment

I agree and disagree! For the past month I been buying ultra shorts when the DOW hits about 9300, and sell around 8300. In one month I made a 90% profit. Theses are not long holds but short bets. With all my profits I will buy good companies for the long haul. Unfortunately my research puts a DOW intra day bottom at 5600-5800 in 3 months. The key to these short term bets is to play the VIX with limit orders and not to get greedy. Take your 30% and get out and wait for a rally to get in. If you think the market is at a bottom, don't short. as for my really negative outlook we still have a lot of pain ahead.
negative personal income growth
real estate fall out in commercial
Consumer spending cuts
job cuts
layoffs
reduced consumption = more layoffs = reduced consumption = more layoffs, LOOP
and don't get me started on the 800 pound gorillia in the room, 70 Trillion in credit default swaps with no cash backstop!
Unlike the past we can't spend our way out of this one. The American consumer is broke, has little home equity/credit to borrow, reduced salary...
This usually makes the gov start a war to throw cash into the system but that's been done already and if anything that stream of moeny will be cut.
All this means a long and slow resession, God forbid a depression.
Time to change how we very our world people.
Good luck to all!!
On October 31, 2008, at 6:10 PM, dragonfly47 wrote: Report this Comment

There will come a time to go long...but that time is many months away. In the meantime, in my search for a way to offset losses and to take advantage of the long slide down in the markets, I discovered short ETF's early this year.
I started raising cash in Feb becaue of fear, having been crushed in 2001. I wanted to short, but also realized there was huge downside risk with any particular stock if things went wrong. That is when I realized I could trade these baskets of stocks just like an individual stock...and then I found the Ultras...both long and short.
Now, I am playing with SRS, TWM, SKF, SCC, SSG, and QID, PLUS the long counterpart for each.
I am almost embarassed about how well this has been working. The volitility has become my best friend.
Oh, by the way, you can make a lot more than 100% on a short ETF. For example, SRS was trading in the upper 60's in mid September. It went over 200 on 10/24.
This is not a game for everyone, and you better be pretty sure what the intermediate term direction of the market or sector is that you are playing in. You need to use disciplined trading ranges and stops. As soon as there is a 20% gain, I rake it off the table. At 30%, I add a trailing stop and play with the percentage as it rises, plus I continue to take increments off the table.
The other cool thing about ETF's is, they will not go to zero and if they go the wrong way on you for a while, patience will bring them back in volitile times. I got way under water on FXP in the spring (got greedy and did not stay in my range), but it finally came back and I got out with a nice gain.
As I said...this is not for everyone.

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