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. (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 doubled (or nearly so) over the past year, and just might be ripe to fall back to earth.

Companies

Recent Price

CAPS Rating
(out of 5)

EZchip Semiconductor (Nasdaq: EZCH  ) $24.43 ****
Satcon Technology  (Nasdaq: SATC  ) $4.33 ***
Incyte (Nasdaq: INCY  ) $16.94 **

Companies are selected by screening for 100% and higher intraday 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.

What do cancer drugs have to do with power conversion? What do either of these things have in common with fables semiconductor chip manufacturing? The answer to both questions is: The companies behind these products are some of the hottest stocks on the Street.

With stock price gains that range from 100% to 200% over the past 12 months, each of these stocks has easily doubled over the past year's time -- but how much longer can the good times roll?

Quite a while longer, according to our CAPS members. Incyte may have doubled in value over the past year, but CAPS member tomfoolme thinks that's only the beginning, now that Incyte has booked its first net profit ... ever.

"Profits, pfui!" replies CAPS All-Star caslonsvcs. Incyte may have profits, but have you seen the revenue growth at Satcon (which incidentally, has nothing to do with satellites.) "Second quarter sales of $27.6 million represented the largest quarter in Satcon's history, reaching revenues over two and a half times greater than ... reported in the same period a year ago."

And yet, the stock Fools seem to favor most is neither Incyte nor Satcon Tech, but a little Israeli chip shop you've probably never heard of. Speaking of which, let's fix that right now.

The bull case for EZchip Semiconductor
Now semiconductor chips, as I'm sure you know, come in many flavors. (I'm partial to sour cream 'n' onions.) Intel (Nasdaq: INTC  ) focuses on PC chips, and ARM Holdings (Nasdaq: ARMH  ) is heavy into lightweight mobile devices, but EZchip's fave has always been the kinds of chips that control the switches and routers that Cisco (Nasdaq: CSCO  ) and Juniper Networks (Nasdaq: JNPR  ) build for use in Internet networking. Within this industry niche, CAPS member sandmanjg tells us, EZchip is a "leader in [the] network processor, [carrier Ethernet/switch router,] and access markets."

Here, lucapacioli1492 tells us, EZchip is "set to lose Juniper as a client, [but] the slack has been taken up by CSCO and it will grow with the latter."

And how much might it grow? jdentinger says EZchip's "chipsets are starting to be delivered in volume and the product breadth is beginning to take shape. They are in the sweet spot of network traffic driven by video and high speed wireless. Securing Cisco as a key customer validates the quality and design wins are in many vendors."

Which certainly sounds good, and explains why EZchip's stock is up so strongly over the past year -- but can it continue to outperform?

I say, "Yea"
At today's high price, you might not think so. But Wall Street at least seems confident in this company's prospects. Growing off a base of $0.67 in per share earnings this year, EZchip's profits are expected to soar 500% over the next four years -- a number that, if achieved, would work out to compound growth of more than 37% annualized. So while 28 times earnings may sound like a lot to pay for a semiconductor shop, it could actually turn out to be a bargain if all goes as planned.

And there's little reason to doubt EZchip will get a chance to capitalize on its potential. The company has a warchest brimming with $83 million in cash to fund its growth, and no debt to detract from it. Plus, with free cash flow strong (stronger than reported earnings, in fact) at nearly $24 million per year, there's little danger of EZchip running down its cash hoard. To the contrary, I suspect we'll even see that cash grow ever greater over time.

Time to chime in
All of which tells me that EZchip is no dud investment. This stock's a rocket, and it's got the fuel it needs to go farther.

Disagree? Feel free. But if you do, please tell us why -- on Motley Fool CAPS.

Fool contributor Rich Smith does not own (or short) shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 562 out of more than 170,000 members. 

Intel is a Motley Fool Inside Value selection. The Fool has written calls (Bull Call Spread) on Cisco Systems. Motley Fool Options has recommended buying calls on Intel. The Fool owns shares of Intel.

Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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