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 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.

Tech's back, baby ...
And with a vengeance. While the market's recent hissy fit may have raised doubts about the broadness and duration of the bull market's run, it's hard to call the gains at these three companies anything other than phenomenal. Over the past 52 weeks, Cree has gone 121% higher, and AMD, 122%.

Success of this sort attracts all kinds of admirers, and they're in no short supply today. At nearly 60 times earnings, Cree looks awfully pricey for a high-tech, "green" lighting play. Yet CAPS member VonMagnusson insists it's worth the price; you have to pay up to own the "Technology front runner in LED Lighting."

Meanwhile, on the other side of the valuation scale, AMD, the perpetual underdog in the battle to unseat Intel (Nasdaq: INTC), sells for a mere 5.8 times earnings. How could this not be a bargain, wonders bc0203, who raves about AMD's "thoroughly modern graphics, scalable chipset architecture with support for all the features that gamers and home theatre PC enthusiasts want ... [and its] combinatoin CPU/GPU that was powerful and inexpensive, yet energy effficient, positioning them well for low-end PCs and portable devices." Yet perhaps because of the numbers in Cree's case, and despite them in AMD's, the majority of CAPS members are still holding back, refusing to assign either stock more than a mediocre two-star rating.

Not so with our third stock. Despite enjoying the steepest run-up in price (137% over the past year, and counting), Brazil's MercadoLibre enjoys the strongest investor support of all the stocks on today's list. Let's find out why, as we examine ...

The bull case for MercadoLibre
CAPS member longbowdon calls MercadoLibre "The latin world's [eBay (Nasdaq: EBAY)]," and says buying it is a "No brainer."

Why? Freedom8082010 explains that Latin American "Internet usage is in its infancy. Broadband and 3G are very young markets as well. The hosting of the World Cup and 2016 Olympics should be a positive for Brazils economy."

What this means, in stokker3's view, is that:

Mercadolibre is a unique opportunity. It is the undisputed online marketplace leader in Latin America. The growth potential of this company is off the charts ... The company is already growing at rapid rates and still has business segments that have yet to hit full stride, like Pago (it's PayPal like payments platform). ... With no debt and excellent cash flow, the company can finance it's own growth through acquisitions on top of the businesses mentioned above.

Exciting numbers
You can practically feel the excitement, the greed for riches, in the words CAPS members are writing about MercadoLibre. Investor sentiment on the stock is about as positive today as I recall it being about Google, Amazon (Nasdaq: AMZN), or Starbucks in their infancy -- but is it justified?

Not necessarily. Not on the facts alone. Selling for 68 times earnings, and for more than 48 times free cash flow, MercadoLibre faces an almost insurmountable hurdle if it's to qualify as an "attractive" investment under most standard valuation metrics. Basically, to justify buying a stock at these valuation levels, you want it to be growing upward of 50% per year, and to keep on growing at that rate for the next five years or so.

Rare indeed are the stocks that pass this test, and MercadoLibre isn't likely one of them, but it does look close. According to the analysts who track it, MercadoLibre is likely to grow its earnings in the neighborhood of 38% per year for the next half-decade. This level of growth is simply astounding, and it has a tendency to render my usual valuation techniques ineffective.

Rocket stock, or dud?
Ordinarily, I try to limit my investments to strict standards of value -- a nice, round, 1.0 PEG ratio such as the one eBay sports, or the slightly more esoteric price-to-free cash flow-to-growth metric, which has me so often singing the praises of fellow e-commerce star Amazon. Stocks with smaller price tags, even if they have slower growth, I have found, are easier to value, and their trajectories more easily predicted.

In contrast, like a spaceship traveling near the speed of light, the rules of investing physics just don't always apply to stocks such as MercadoLibre, still in the hypergrowth stage. So while I personally have little desire to ride this particular rocket, I'm unable to state with any conviction that the rocket will run out of gas. Put another way, just because MercadoLibre has already shot to the moon doesn't mean it's not going to make it to Mars.

Disagree? Think I'm being too generous, and MercadoLibre is priced too high? Go ahead and make your case. We've even got a place for you to do it -- on Motley Fool CAPS.