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 up.

Problem is, if the price goes up too much, even a great company can turn into a lousy investment (and if the company was less than great in the first place ...) Below, I list a few stocks that may have done just this. 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):

Yongye International (Nasdaq: YONG  )

$8.22

*****

Cree (Nasdaq: CREE  )

$72.18

**

Vonage (NYSE: VG  )

$2.36

*

Companies are selected by screening for 100% and higher price appreciation over the past 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.

Riddle me this: What do high-tech Internet telephony, LED lighting, and Chinese fertilizer have in common? Answer: The companies behind these products are some of the hottest stocks on the Street.

Over the past year, shares of Cree have more than doubled. And rightly so. After all, CAPS member Dnomyar220 predicts that eventually, "Everybody needs to transition into LED lighting ... and CREE is one of the pure breeds in the LED lighting industry." It's got a market share roughly as large as that of Philips (NYSE: PHG  ) , and more share than lighting incumbent General Electric (NYSE: GE  ) .

Vonage is doing even better. CAPS member wiggster1 calls the stock "a remarkable turn around story," and Vonage has the numbers to back that up, as the shares have risen an astounding 475%.

Too far, too fast?
By contrast, at a mere 105% gain, Yongye International looks like a bit of a laggard -- and yet, among Foolish investors on CAPS, it's far and away our favorite. Let's find out why.

The bull case for Yongye International
Never heard of Yongye? Allow CAPS member tytymhorau to introduce you to this: "Chinese ... micro-cap producing bioengineered nutrient compounds for plant and animal feed in China." According to tytymhorau, Yongye "Should profit from the push to improve agricultural efficiency/food quality and availability for the country's [burgeoning] population."

It's also, as All-Star investor RedDoor9 points out, a "Cash rich company operating in booming sector of the fastest growing economy in the world. I liked their move to buy the supplier of one of their main product ingredients. The business strategy they employ to add new vendors at low costs should also be a strategic advantage."

Put it all together, and rumymudda believes Yongye offers investors "Good growth potential at a good price."

Polite disagreement
And yet, how do I put this politely? I have to disagree pretty strongly with my Foolish colleagues on this one. I mean, to an extent, the CAPS members endorsing Yongye make some good points. For example, the "cash rich" comment that RedDoor9 contributed. With a market cap of barely $370 million, but $50 million in net cash on its balance sheet, fully 13.5% of this company's capitalization is backed up by cold, hard cash. That's a nice margin of safety there.

Problem is, that's all there is. Sure, Yongye built up a pretty pile of cash from last year's stock offering. But it's the reason it needed to conduct the offering at all that is the real story here. Over the entire course of its publicly traded history, Yongye has failed to contribute one red cent (yuan or renminbi) to its cash hoard from actual free cash flow. While it's true that Yongye continues to report "profits" on its income statement, the company's cash flow statement is an unbroken stream of red ink, and one that shows Yongye still burning cash at an annual rate approaching $2 million.

A modest suggestion
If you absolutely, positively feel you must invest in the agricultural fertilizer sector, why waste time on Yongye when you have the option of owning a company like PotashCorp (NYSE: POT  ) , which -- whatever you may think of its valuation today -- has at least proven it can generate positive free cash flow from time to time. Or Mosaic, which despite all the turmoil in the sector of late is still generating cash from its business on a trailing 12-month basis.

Certainly, Fools like rumymudda can argue that a tiny, China-focused shop like Yongye has more "potential" than older players in agriculture. But even there, it seems to me that you've got better alternatives than Yongye. China Green Agriculture (NYSE: CGA  ) , for example, carries a market cap that's $100 million less than Yongye's (and it has more cash to boot), yet it has already broken the positive-free cash flow barrier, generating $8 million of the stuff over the past year.

Rocket stock, or dud?
Maybe I'm totally off base about this (and if you think so, feel free to tell me why below, or on the Yongye discussion board at Motley Fool CAPS). But for all the world, Yongye looks to me like the very epitome of a dud investment, one that makes its living on "the kindness of strangers" who buy its secondary stock offerings, rather than fending for itself and generating cash on its own.

My advice: I wouldn't touch this stock with a 10-foot pitchfork, and you should not either.

Rich's reservations notwithstanding, both China Green Agriculture and Yongye International are Motley Fool Global Gains recommendations, and The Fool owns 'em both itself. Fool contributor Rich Smith, in contrast, does not own shares of any company named above. You can find Rich on CAPS, publicly pontificating under the handle TMFDitty, where he was recently ranked No. 491 out of more than 165,000 members. The Fool has a disclosure policy.


Read/Post Comments (10) | Recommend This Article (13)

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 July 26, 2010, at 4:42 PM, a2investments wrote:

    Okay, let's look at the change in cash flow and revenue for POT and YONG, 2009 vs. 2008:

    POT

    cash flow: -146%

    revenue: -58%

    YONG

    cash flow: +71%

    revenue: +105%

    A very different picture. Also, YONG is a young company, whereas POT is mature. The comparison isn't fair in any case.

  • Report this Comment On July 26, 2010, at 11:22 PM, EriKarju wrote:

    Few things missed by the writer of the article.

    1. On quarterly basis both YONG and POT have been operational cash flow negative 4 out of last 5 quarters, turning positive during Q1 2010. What’s the difference?

    2. YONG and POT are both in a seasonal business, but YONG is growing fast and with geographically more limited markets more subject to seasonality. With limited capacity Yongye must depend more on off season high production rates than larger POT, just to stock inventories during the off season to cover for the coming high seasons. If the writer would have taken a look at Yongye’s quarterly inventory build-ups as shown in the company’s balance sheets that fact would have been obvious to him. So what does the inventory build-up have to do with free cash flow: production for the coming year’s growth ends up being a drag on this year’s cash flow. An example, if Yongye had chosen to keep inventories at the end of the year 2009 at the level of the end of 2008, most of the 21 million hit for operational cash flow would be absent and the said cash flow would be plenty positive, but growth in 2010 might have taken a serious hit. Actually, just 10 million cut there would have made Yongye’s free cash flow for 2009 match China Green Agriculture’s.

  • Report this Comment On July 27, 2010, at 4:14 AM, RedRusty wrote:

    The thing I most like about the Nasdaq listed Chinese stocks, is that so many of the “investors” following them simply have no idea what they are doing. Inadequate forecasting, inappropriate comparisons and, quite frankly, inept analysis mean there are plenty of opportunities for those of us willing to do some hard work. Usually when I read poorly conceived trading ideas on blogs or websites I simply ignore them, but every once in a while I stumble upon a post so overwhelmingly mis-guided I have to respond. Such is the case with “Rocket Stock or Dud” and its attempts to convince us that Yongye International (YONG) is a poor investment because they haven’t yet generated much cash. I won’t go into a detailed description of YONGs business – there are already enough posts on the subject, but I’d encourage you to go to the company website and download their latest investor presentation. Management issued medium term guidance last year, and they said they would achieve “at least” 50% revenue growth year on year in 2010, 2011 and 2012. So far this year they have already upped full year sales estimates TWICE, and now this year’s guidance is about 85% higher than 2009. If the company meet their 2011 and 2012 guidance – and having met the management I fully believe they will – then sales between 2009 and 2012 will have grown over 4-fold.

    Now growth like this takes investment. The production capacity in 2009 was increased massively over 2008 as demand for their products was so high. Then at the end of ’09 the company announced a plan to further triple their production capacity – this is because as they expanded their number of retail outlets from 1,125 in 2008 to a planned 20,000 by the end of 2010 it became obvious that demand would easily outstrip supply. Due to cyclicality of the business, coupled with massive year on year demand growth, management initiated a number of additional plans. Firstly they bought out the supplier of their main raw material – vertically integrating themselves, and gaining better control of their input costs. Secondly they started building inventory levels - Q2 and Q3 are the key volume quarters for agri-companies in china, and as planned sales were much higher than peak capacity they had to plan ahead. The build up of inventory, the acquisition of the raw material supplier, and the further acquisition of a distributor’s supply chain would’ve been a serious draw on capital for such a young company – and so some new equity was issued to fund it. The new production facilities are due to be open in the next few weeks, but in the mean time de-bottlenecking has meant a 50% increase in output has been achieved at the current facilities in Q2 – management recently announced that all this addition production has been sold out.

    So now the company is in the position to meet their guidance for the next few years. Consensus earnings for this year currently stands at around $1.10 per share. If you assume 50% earnings growth for the next 2 years, based on the 50% revenue growth guidance (obviously I’m completely ignoring the operating leverage effect of having gross margins around 54%, and operating margins around 35% - but let’s be conservative) then you get $1.65 next year, and $2.40 the year after. Cumulatively that’s $5.15 – but now look at the balance sheet : $50m in cash, and $46m of inventory. When the inventory is sold down it will generate sales of around $100m – adding $85m post tax to the cash pile.

    So how does YONG look as an investment to me ? Well if you buy it today around $8 then over the next couple of years you will generate over $5 per share in eps, plus there will be about $3 per share in cash on the balance sheet – that’s your entire investment, effectively covered – the stock is basically pricing in no earnings whatsoever beyond 2012. The vertical integration means the cash requirement for the business is going to be much lower going forward, so you should expect to see some huge cash returns in the near future. To compare POT and YONG, simply on the basis of them both producing fertilizer products is not only lazy, but also dangerous – but hey, if I can profit from other people’s misconceptions then keep up the good work !

  • Report this Comment On July 27, 2010, at 10:27 AM, murph83 wrote:

    Yongye has funded itself by issuing more shares, that's true. They have also absorbed the additional shares and have a lower PE than before(going forward). To blast funding by additional share offerings and then offer CGA as a superior company is interesting as CGA just filed a shelf offering for 200 million additional shares. I own both but really like Yongye. They are priced 30% below CGA and have higher earnings projections for both this year and next. They also have a big four auditor so you can feel comfortable with their numbers.

  • Report this Comment On July 27, 2010, at 10:37 AM, TMFDitty wrote:

    "They also have a big four auditor so you can feel comfortable with their numbers."

    I keep reading this comment made in relation to Yongye, on discussion boards across the 'Net. Does no one remember Enron anymore? WorldCom? These companies were not audited by Billy Bob's Accounting Shack, you know...

    Having spent many years working at BigLaw with the vaunted Big Four, Five, and Six auditing firms, I really think people give too much credence to their competence.

    TMFDitty

  • Report this Comment On July 27, 2010, at 3:00 PM, EriKarju wrote:

    TMFDitty,

    are you saying that having a big, internationally respected auditor does not matter? Please tell that to China Northeast Petroleum investors. Also, Arthur Andersen, the auditor for both WorldCom and Enron paid dearly. Maybe the remaining big auditors learned something.

    Anyway, sticking to auditors is rather weak defense of your thesis here.

  • Report this Comment On July 27, 2010, at 3:46 PM, Swede46 wrote:

    TMFDitty,

    TMF refers to Fools and being Foolish as a compliment with a capital F, and the usual meaning of the word with a lower case f.

    Most TMF articles end with the writer encouraging readers to do their own DD. Your article stated that "I wouldn't touch this stock with a 10-foot pitchfork, and you should not either" A rather profound statement from someone who obviously nas not done any DD on the company and is basing an opinion on the investment using only one metric. Based on your stated employment history, I would have expected better from you.

    The disclaimer states that YONG is a recommendation on GG and that Motley Fool owns the stock. One of the two of you has to be foolish with a lower case f.

  • Report this Comment On July 27, 2010, at 4:47 PM, paddlinfaster wrote:

    So what you are basically saying is that the HEAD guy of Global Gains is an idiot as he can't recommend the company & the stock any more HIGHLY?

    I feel sorry for all the 'day' readers of Motley Fool who do not subscibe to that newsletter & instead believe this view represents that of "the Motley Fool". It does NOT.

    And if you really think you could stand the humiliation, you should offer the readers here a point-counterpoint with Tim.

  • Report this Comment On July 27, 2010, at 5:16 PM, Swede46 wrote:

    I know The Motley Fool promotes independent thinking and welcomes contrary wiewpoints. That said...this article is an example of that philosophy run amuck.

    The advisors on the paid services have no control on the content posted on fool.com. In principle, that is good.

    The Gardner brothers have an admirable goal in leveling the playing field for the individual investor. They also ended up with a gold mine, which depends on people being impressed enough with the information posted on the open site to subscribe to their paid services. This is an open invitation to the Gardner brothers. Do you think this presents your service in a favorable light?

  • Report this Comment On July 28, 2010, at 12:48 AM, Edmundoluk wrote:

    There has been so much talk about this being a poorly researched, highly irresponsible and inaccurate post that I finally decided to come take a look. Perhaps these folks are simply indignant that someone dared to say something bad about their darling YONG? Perhaps I should re-balance my portfolio, sell all my YONG and buy more CGA? (Disclosure: I own both CGA and YONG shares, as well as CAGC)

    Ok I read this article and did some fact checking, and I am confused. First of all, this article said “you've got better alternatives than YONG”, with a hypertext link. I followed the link to an article which rated YONG at the very top of the bunch, so where are the better alternatives? This article then further proposed CGA as a better alternative to YONG, saying that CGA "has already broken the positive-free cash flow barrier, generating $8 million of the stuff over the past year". CGA did generate more than $7 million operating cash flow over the past year, but it also had large capital expenditures like YONG, and ended up with NEGATIVE free cash flow for the entire year, and prior to that as well. You think CGA's new state-of-the-art processing plant and the massive greenhouse complex do not cost a lot of cash? The point is, as high growth companies both CGA and YONG have negative free cash flow and have to finance their high growth by selling new shares – it's par for the course. Sounds like the article's author did not understand the difference between "operating cash flow" and "FREE cash flow" (and there is a huge difference) and was happy to compare apple to orange. Either that, or he did some very sloppy fact finding before generating and publishing his analysis.

    I have no doubt there are plenty of investors out there who view free cash flow as the paramount factor for their investment, and I respect that. These investors also tend to favor predictable income such as a steady or even increasing dividends, because a company must have good free cash flow to issue dividends. Companies that fit this profile are blue chip stocks that are solid and many of them even grow consistently, but none of these mature companies grow close to CGA's 40% to 50%, let alone YONG's almost 100% a year. You want to invest in growth stocks? You had better not be using free cash flow as a way to find your stock, because you won't find them. If you somehow find a stock that's growing at 100% and still has strong free cash flow, the PE would be so high that I, to borrow the colorful phrase from this article's author, “would not touch the stock with a 10-foot pitchfork”

    I have no idea what this author's investment style is - after all he is only another amateur like any one of us. But I can understand why he "wouldn't touch this stock with a 10-foot pitchfork". If he is a very conservative or income-oriented investor, he has every reason not to be buying YONG or CGA, but I wish he would make that clear. In the end I must agree with the other posters that the inaccurate facts and inappropriate comparisons in this article reflect very poorly on Motley Fool. As for me, I am staying put with both YONG and CGA.

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