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 upwards.

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 over the past year, and just might be ripe to fall back to earth.

Companies

Recent Price

CAPS Rating (out of 5)

Frontline (NYSE: FRO  )

$35.56

*****

U.S. Steel (NYSE: X  )

$59.81

***

UAL Corp

$22.83

*

Wynn Resorts (Nasdaq: WYNN  )

$83.82

*

Priceline.com

$254.86

*

Companies are selected by screening for 100% and higher price appreciation over the last 12 months on finviz.com. Five stars = highest possible CAPS rating; one star = lowest. Current pricing provided by Yahoo! Finance. CAPS ratings from Motley Fool CAPS.

Since the darkest days of early 2009, a change has come over the markets. People are starting to talk about an economic recovery more … and about the end of civilization as we know it, less. Reports out of the Institute of Supply Management tell us that manufacturing activity grew in March, and depending on how you read the data, it's even possible we're seeing "green shoots" in the American labor market. So … is now the time to buy back in?

Not necessarily. Judging from the ratings being handed out by our CAPS community of investors, there's a real split evident in the market right now. Some of the best-performing stocks of the past year are expected to keep plowing higher. More ominously, however, Fools think there are quite a few high-flyers out there whose stocks are poised to plunge.

Obviously, as investors we're more interested in investigating the former than the latter. And according to our lay stock analysts on CAPS, there's no one better positioned to profit from a global economic recovery than Frontline. This, therefore, will be our featured stock of the week.

The bull case for Frontline
Over the past 12 months, Frontline shares have outpaced the S&P 500's performance by some 60 percentage points -- and CAPS member rodney15 says that's only the beginning. Plus: "as oil prices increase, look for an increase in dividend soon also, which would help appreciate the value of the stock."

Aristocrisis agrees: "Tanker rates cannot stay low for long. Great dividend history, and probably future. [CEO] Mr Fredriksen is also the meanest wolf out there."

And vin302th, in addition to oil price trends, sees another macro phenomenon working in Frontline's favor: China. Says he: "Frontline will sail high on chinas growth, in a couple of years the super dividend will return to John Frederiksen normal strengh"

Is it just me …
… or do I detect a theme running through these comments? (Give ya a hint: It starts with the letter "d".)

What, I wonder, is this obsession among investors with the level of Frontline's dividend? Well, I'll tell you: It stems in large part from the fact that historically, dividends have been the reason to want to own Frontline. While the company paid out $0.90 per share last year, and has only promised to up that by a dime in 2010, over the five previous years, this company paid its shareholders anywhere from $6.50 to a whopping $8.10 per share -- pretty heady yields for a company that traded mostly between $30 and $70 over that period.

So you can see why investors are unenthused about Frontline's current 2.8% divvy. Measured against the historical yardstick, it looks miserly in the extreme. For that matter, if you compare Frontline to what competitors like General Maritime (NYSE: GMR  ) and Teekay Corp (NYSE: TK  ) are paying, Frontline looks positively stingy today.

But here's the thing: With nearly 50% of its free cash flow already earmarked for dividends, I'm not sure that Frontline has enough cash-generating prowess to satisfy all the Fools clamoring for a higher dividend. Dividends don't grow on trees, you know, nor float freely for the scooping-up, atop the high seas. To fund 'em, a company needs to earn profit. But according to the analysts who track Frontline, this company is only going to earn about $2.44 a share this year -- and even less over the next year.

So even if Frontline were to devote every penny it earns to paying dividends (rather than to, say, paying down its mammoth $2.7 billion debt load), the most investors could hope for would be a 7.0% yield -- just a fraction of Frontline's dividend yields of yore. Worse, as earnings fall back, so too would the yield.

Foolish takeaway
I hate to break it to you, Fools, but if the money's not there, it's not there.

There's only so much blood you can squeeze from a turnip -- and a debt-laden oil shipper can only leak so many dividend drops. 14.6% Frontline dividends are not returning any time soon. (That is to say, not without a precipitous drop in the stock price, which I doubt would please Frontline investors any better.) Meanwhile, at 27 times trailing earnings, 14 times next year's, I find it hard to invest in the stock on its valuation either.

Put it all together, and I'm forced to conclude: Frontline's a dud.

Or so say I -- but don't be shy. If you disagree with my take on Frontline, here's your chance to "silence the critic." Click over to Motley Fool CAPS now, and tell me why I'm wrong.

What kinds of stocks have better chances of and increasing their dividends -- and your wealth? These kinds of stocks.

Priceline.com is a Motley Fool Stock Advisor pick, but Fool contributor Rich Smith does not own shares of, nor is he short, any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 701 out of more than 160,000 members. The Fool has a disclosure policy.


Read/Post Comments (2) | Recommend This Article (10)

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 April 21, 2010, at 12:22 PM, TLassen wrote:

    OMG....

    "But here's the thing: With nearly 50% of its free cash flow already earmarked for dividends, I'm not sure that Frontline has enough cash-generating prowess to satisfy all the Fools clamoring for a higher dividend. Dividends don't grow on trees, you know, nor float freely for the scooping-up, atop the high seas"

    Before writing articles like this, maybe check out their business model.......you cannot apply normal payout ratios to FRO and tell readers that 50% it's free cash flow earmarked for dividends is a problem.

  • Report this Comment On April 28, 2010, at 4:22 PM, unfatcat wrote:

    The Chinese and the Indians will build and buy and drive more cars. Frontline will deliver oil to them. It will make the payments for the tankers it has bought. Profits will rise. Dividends will flow.

Add your comment.

DocumentId: 1157202, ~/Articles/ArticleHandler.aspx, 4/19/2014 8:42:39 PM

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