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)

Rockwood Holdings (NYSE: ROC  )

$44.65

*****

Whole Foods (Nasdaq: WFMI  )

$59.67

***

Sina Corp (Nasdaq: SINA  )

$93.16

***

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.

Question: What do hi-tech chemicals have to do with organic groceries? What do either of these things have in common with Chinese Internet ads? Answer: the companies doing business in these fields boast some of the hottest stocks on the market today.

Shares of Rockwood Holdings and Whole Foods have both more than doubled over the past 52-weeks, while Chinese Internet star Sina has done even better -- up nearly 160% in a year. Yet while the stocks have all enjoyed strong price appreciation historically, investors differ widely in their opinions on which of these companies will keep on growing in the future.

When polled for their opinions on which of these stocks will outperform the S&P 500 going forward, the 170,000-plus investors who make up the Motley Fool CAPS give Whole Foods and Sina no better than 50-50 chances. In contrast, they couldn't be more enthusiastic about the prospects for Rockwood Holdings. Why is that? Well, why don't we ask the Fools who help create these ratings.

The bull case for Rockwood Holdings
You can't open a news paper these days without reading about a new electric car coming to market. General Motors (NYSE: GM  ) and Nissan have already begun rolling out their Volts and Leafs, respectively. Ford's (NYSE: F  ) Electric Focus could begin showing up on auto lots any month now, while Tesla (Nasdaq: TSLA  ) is hard at work getting its Model S electric sedan (sequel to the fabulously popular, and even more fabulously expensive Roadster) ready for market. Late last year, no lesser company than General Electric (NYSE: GE  ) made a big bet on the industry's success, promising to spend as much as $1 billion on electric cars for its own use over the course of the next few years.

The key to powering all these new electric buggies, of course, is the advanced lithium battery -- and that's where Rockwood enters the picture. CAPS member newfoolrr tells us that Rockwood is already "a major player in the lithium ion batteries market. ... I believe in the next five years that the price of lithium will explode. I believe Rockwell is the best play in this market."

CAPS member DigitalPaladine agrees: "Demand for lithium is snowballing and this company is poised to reap tremendous gains from this." But Rockwood's other operations are no slouch, either. For example, DP tells us that Rockwood boasts a "100% market share in the plastics used to create artificial hip and joint replacements in the US."

Indeed, All-Star investor silentrumble recently picked Rockwood to outperform based largely on its being "diversified in several other high tech industries" aside from lithium "titanium dioxide for plastic and paint additives, for example." Silentrumble calls the stock a "very favorable value at this stock price considering the current cash flow and future growth projections."

Crunchy lithium
I agree. Crunching the numbers on this lithium (and not just lithium) play, we find Rockwood selling for 24.6 times trailing earnings. That might sound expensive, but the consensus on Wall Street is that the boom in lithium demand could cause Rockwood to grow those earnings as fast as 34% per year over the next five years. And it gets better.

Examine Rockwood's cash flow statements, and what you'll find is that Rockwood is already cheaper than it looks. The company reported $141 million in earnings under GAAP over the past year, but its actual free cash flow number is more than twice as big -- $294 million.

Time to chime in
What this means is that Rockwood's supposedly rich P/E ratio is actually an illusion. Valued on actual cash earnings, the company sells for a more modest 11.2 times free cash flow (or 17.1x, after you factor in the company's debt load). Any way you look at it, though -- P/E, P/FCF, or even EV/FCF, the stock looks quite attractive relative to that 30%-plus growth rate. 

To my Foolish eye, this is one rocket stock that's still got fuel in the tank. Disagree? Hey, it's a free country. But won't you take a moment to tell us why? If you've got a bone to pick with Rockwood, click over to Motley Fool CAPS now, and sound off.

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. 729 out of more than 170,000 members. The Fool has a disclosure policy.

General Motors is a Motley Fool Inside Value pick. Ford Motor, Sina, and Whole Foods Market are Motley Fool Stock Advisor choices. The Fool owns shares of Rockwood Holdings.

Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.


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  • Report this Comment On February 14, 2011, at 4:34 PM, plange01 wrote:

    any money disgraced gm earns needs to go to compensate its former stockholders who were robbed by obama's illegal fake prepackaged bankruptcy...

  • Report this Comment On February 14, 2011, at 6:59 PM, phoebe44 wrote:

    Amen, plange01, Amen!

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