Rocket Stock or Dud?

"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 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 120,000 stock gurus (and counting) in CAPS have to say about the list's latest contenders:

Stock

One Year Ago Today

Recent Price

CAPS Rating

(5 max):

Short QQQ ProShares (AMEX: PSQ  )

$51.08

$83.82

*

UltraShort Technology ProShares 

$49.75

$124.00

**

UltraShort Semiconductor ProShares

$55.91

$153.60

*

Short MidCap400 ProShares (AMEX: MYY  )

$57.67

$92.76

**

UltraShort Russell1000 Growth ProShares 

$59.51

$143.16

*

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. CAPS ratings from Motley Fool CAPS.

"Everybody loves a winner"
So people say -- but this week, winners are rarer than feline synchronized swim teams. Across the three major U.S. stock exchanges, precisely one stock closed out last week at a new 52-week high: a small-cap, AMEX-listed shell corporation named "Granahan McCourt Acquisition Corporation," that trades for less than its cash in the bank.

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 (if you can call Granahan that), but 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 have one thing in common: They're all short bets against various market niches. And what does this tell us?

Investors are shorting the Naz. Shorting tech. Shorting semis, mid caps -- why, they're literally selling "growth" short!

Big mistake. Huge.
CAPS members think this an extremely risky strategy. These ETFs have one thing in common, in that they represent short bets, but they also have another: below-average one- and two-star ratings on CAPS. By massive majorities, Fools think it's foolish -- not Foolish -- to bet against the U.S. economy.

Sure, short term (pun intended), 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, $1000 can grow into $1 million in a matter of just a few decades -- because a stock that starts at "1" can eventually "go to 11" and beyond. In contrast, the best a short bet can ever yield is a 100% gain, as "1" plummets hopelessly to "0."

Need more convincing?
Say you had a crystal ball five years ago. Say you knew that over the course of five years, each of Amazon.com (Nasdaq: AMZN  ) and eBay (Nasdaq: EBAY  ) , Ford (NYSE: F  ) and General Motors (NYSE: GM  ) , were 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 shorting would have generated a combined profit of $2,220 as Amazon lost 11% of its value and eBay 47% -- while Ford and GM each vaporized more than 80% of their shareholders' money.

Hard to beat a take like that, right? Wrong. If instead of lucking out and guessing right on these four stocks, you instead bought just one great stock back then -- say, Vale (NYSE: RIO  ) -- you would have earned more from Vale's 225% increase in value than 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.

We haven't given up on eBay and Amazon.com yet. Both remain Motley Fool Stock Advisor recommendations.

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. 559 out of more than 120,000 members. The Fool has a disclosure policy.


Read/Post Comments (0) | Recommend This Article (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 Report this Comment icon found on every comment.

Be the first one to comment on this article.

DocumentId: 763483, ~/Articles/ArticleHandler.aspx, 8/1/2014 8:21:53 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement