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 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 130,000 (and counting) stock gurus 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 Friday last week. One year ago price provided by Yahoo! Finance, recent price and CAPS ratings from Motley Fool CAPS, all as of 4/17/09.

"Everybody loves a winner"
Um, apparently not. In fact, it's been quite a while since I came across a list of 52-week-high-hitters that looked more un-loved than this bunch of proverbial "look what the cat dragged in" stocks.

Seems Fools see no future for Macrovision and think Sourcefire's a flame-out; they'll issue no visa to Kirkland's, and consider Darden's Restaurants unsanitary. But as down as investors are on these four, they reserve their most vehement contempt for tobacco magnate Star Scientific -- consigning it to the black hole of CAPS' lowest possible rating. Here's why:

The bear case against Star Scientific

• CAPS All-Star FinancialModeler made the strongest case on record against Star last summer. Let's lead off with this one: "The fundamentals of this tobacco company are atrocious. ... The company makes no profits. Sales have fallen almost 100% from 2004. ... They are diluting shares outstanding to raise more capital and also are selling bonds which no doubt must be junk status. This is the only way STSI can finance its operations. It is not making any money from the selling of a product."
• Nor is FinancialModeler the only Fool unimpressed with Star's business model. tthwebster agreed in December that this firm has an "awful lot of red on the balance sheet for a company trading near 52 week high," calling the stock "horribly overvalued." And lfjl is even more succinct (and colorful), calling Star "a walking zombie."

Think these Fools doth protest too much? Well, look for yourself:

• Since 2003, Star has burned through $70 million in cash from operations over the last five years, and cash burn has accelerated over the last couple of years.
• Debt is down ... but shares outstanding are up 67% over the same time period.
• And I see absolutely no prospect for a turnaround in the "business" -- because there isn't much of a business to turn around. Over the whole of last year, Star made less than half a million dollars in sales, giving the firm a price-to-sales ratio in excess of 1100, and a P/E that I'll leave to your imagination (which is the only place it can exist -- the company had a net loss of over $18 million).

Foolish takeaway
Listen, Fools, I'm no anti-tobacco crusader, blasting Star solely because of its stock in trade. Fact is, I have every confidence that companies like Phillip Morris International (NYSE:PM) and Altria (NYSE:MO) can and will generate profits for years to come. (Because whatever your feelings on the product, it's a product in demand, and people will pay up for it.)

My objections to Star Scientific are based solely on the fact that the company has no apparent demand for its products, consequently no profits from the sale thereof, and seems to subsist entirely on the "kindness of strangers" -- the investors who finance its money-losing ways by buying into the ever-rising sharecount.

To me, that seems a fool's errand -- small "f." But hey, if you disagree, knock yourself out. If you think I'm wrong about this one, go ahead and tell me why.