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.

Now I readily admit that sometimes, stocks rise for a reason. But sometimes, the rise becomes the reason. No matter how often we caution them not to, investors do have a habit of buying "hot" stocks, and trusting momentum to keep 'em moving upward.

Problem is, if the price goes up too much, even a great company can turn into a lousy investment. Below I list a few stocks that may have done just that. Stocks that, according to the smart folks at finviz.com, have more than doubled since the beginning of this year, and just might be ripe to fall back to earth.

Stock

Recent Price

CAPS Rating
(out of 5 stars)

Teck Resources  (NYSE: TCK  )

$12.10

*****

Brocade Communications  (Nasdaq: BRCD  )

$5.98

****

Cell Therapeutics (Nasdaq: CTIC  )

$1.19

****

RF Micro Devices  (Nasdaq: RFMD  )

$2.22

****

XL Capital (NYSE: XL  )

$8.93

*

Companies are selected by screening for 100% and higher price appreciation year-to-date on finviz.com. Five stars = highest possible CAPS rating; one star = lowest. Current pricing provided by Yahoo! Finance. CAPS ratings from Motley Fool CAPS.

Each of these stocks has enjoyed remarkable gains over the past five months. But if you ask the 130,000 (and counting) investors who make up Motley Fool CAPS, not all of them deserve those gains. One stock in particular stands out as particularly lacking in investor love. Let's find out why, as we examine ...

The bear case against XL Capital
As far back as a year ago, CAPS All-Star shop1 criticized XL for reporting: "a dramatic decrease in Q1 net income, down from $562.5 million to $244.4 million. The company's investment portfolio lost $1.4 billion and its insurance divisions profit was squeezed as more claims were paid & insurance premiums were decreased due to competition."

After seeing the firm's stock leap from $2.82 to $4.55 in early February 2009, Fellow CAPS member cbwang888 characterized the firm's "60% jump in a day" earlier this year as "short covering." And indeed, the stock did fall right back down in short order ... but has since recovered to rise another 96% beyond that supposed "short covering" rally.

That rise sure sounds like good news -- but some Fools remain unconvinced. Yet another of our All-Star investors, Smith568, looks at the stock's continued rise and concludes only that XL is a: "Weak company... not worth this price."

So what is XL, really? Is it a real rocket stock, or a dud that doesn't know it yet? I see several reasons to be suspicious of XL Capital. First, while the stock has a decent combined ratio of 95.7%, that number is up sharply from where it held over the past couple of years. I also cannot help but notice that the firm's expense ratio (one component of the combined ratio) has risen for three years straight.

Now, this is not an issue isolated to XL. Montpelier Re (NYSE: MRH  ) is showing similar trends, and to a lesser extent so is insurance industry standard Berkshire Hathaway (NYSE: BRK-B  ) . But that still leaves us with two undeniable facts that argue against investing in XL:

  • First, just because bad things are happening to everybody (generally), doesn't mean you should ignore them happening to anybody (in particular, XL).
  • Second, XL's combined ratio is clearly the worst of the three insurers named, begging the question: Why buy it at all when there are better choices available?

Time to chime in
Of course, the aim of this column isn't to tell you what I think about XL Capital. On this question, there are far wiser Fools to whom you should listen first. In fact, perhaps you're the one who should be telling us about the company. If you've got an opinion, we've got a place to voice it.

Motley Fool CAPS: It's fun, it's free, and it just might make you famous.

Berkshire Hathaway and Montpelier Re Holdings are Motley Fool Stock Advisor picks. Berkshire Hathaway is also a Motley Fool Inside Value selection, while Montpelier Re Holdings is also a Motley Fool Hidden Gems recommendation. The Fool owns shares of Berkshire Hathaway.

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. 427 out of more than 130,000 members. The Fool has a disclosure policy.


Read/Post Comments (6) | Recommend This Article (52)

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.

  • Report this Comment On May 18, 2009, at 3:09 PM, SkeeDaddy wrote:

    While your comments make a great deal of sense, the risk-reward ratio for some stocks (particularly Cell Therapeutics) can make a "speculative" investment worthwhile. Arguably, CTIC has the potential to be a $50 stock with two or three very promising drugs in Phase II and Phase III trials. If only one (Pixantrone) is approved by the FDA, the potential revenues could reach $1 billion or more. For me, it represents a more promising "investment" than the purchase of a lottery ticket. However, I would NOT "sell the farm" for this or any other stock.

  • Report this Comment On May 18, 2009, at 3:45 PM, superdavewetzel wrote:

    With regards to Brocade (BRCD), I do agree that the stock seems to be teetering at the top of a fast run up. I like the company, but w/ earnings coming out this week, anything less than a home-run earnings announcement couple be pullback. Tread carefully.

  • Report this Comment On May 19, 2009, at 11:34 AM, bigRebel wrote:

    This assessment of XL as a rocket stock ignores the relative strength of the new management team, discounts the realities of constrained insurance capacity at a time when such capacity is in renewed high demand, and overlooks particulars of the uniquely (and well) regulated Bermuda market. Over a period where few escaped the global financial troubles of 2008, to pay myopic consternation on last year’s predicament is tantamount to spreading falsehoods. Fool then seems the right moniker for such ignorance.

  • Report this Comment On May 20, 2009, at 2:56 PM, unkelmarkmark wrote:

    I agree with Skeedaddy. Consider what DNDN recently did. The stock was languishing sideways in the $4 range and then they release a report that shows their drug prolongs lifespan an extra 4 months, which was the minimum expectation and the stock goes to $27.00

    I could prolong your lifespan by 4 months by prescribing red wine. I mean that drug is a JOKE and look at the stock gain?

    Don't fight the tape as they say. CTIC just needs to post average test results for the stock to shoot up to $10.00 or higher.

  • Report this Comment On May 21, 2009, at 2:57 PM, DEALWITHTHEDAY wrote:

    Total Cash (mrq): 7.20B

    Total Cash Per Share (mrq): 21.054

    Total Debt (mrq): 2.63B

    Total Debt/Equity (mrq): N/A

    Current Ratio (mrq): 2.943

    Book Value Per Share (mrq): 17.945999

    Here are the numbers from Yahoo.

  • Report this Comment On May 24, 2009, at 1:35 AM, luciouscalvin wrote:

    so you guys have this site but you are confusing me as each report seems to go against, then for,then against ctic. SO SHOW US SOME COURAGE THEIR AND TELL US DIRECTLY WHAT YOU THINK.BUY IT OR DONT???

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