Are These Stocks Doomed to Drop?

After a seemingly endless losing streak, stocks finally managed to close out a winning quarter last week. But as the rally has started to stall out, smart investors are keeping an eye on their portfolios -- and looking for signs that some of their stocks may have risen so fast that they won't be able to sustain their gains.

Where did the value go?
Value investors always look for strong stocks at bargain prices. At the market's lows in March, those who sought out good value stocks enjoyed a veritable all-you-can-eat buffet of potential selections. The extremely steep and rapid bounce off those lows gave opportunistic investors a quick payoff as a reward for their courage.

Now, though, a number of stocks don't look anywhere near as cheap as they did a few months ago. Take a look at some examples:

Source: Yahoo! Finance. P/E = price-to-earnings ratio.

Granted, with the earnings multiples mentioned above, stocks like these might not have shown up on some value investors' radar screens even when they were cheaper by a third, or even a half. Yet value screens that rely too much on absolute levels of P/E ratios can overlook a number of rare bargains among stocks whose potential for future growth will keep them from ever trading at earnings multiples below the broad market's average.

In other words, if you limit yourself to purchasing stocks with single-digit P/Es, you're going to miss out on some great returns like these stocks have had over the past few months. Now, though, the question is whether those gains are sustainable, whether it's too late to buy in for further gains, and what you ought to do next if you already own them.

Don't fall in love
Before you decide what to do though, here's one thing not to do: Don't hold onto them just because they were a smart buy back in March. You've already seen the gains from that decision, and what may have seemed like a good stock at $20 could prove to be ridiculously overpriced at $40.

That said, if you already own these stocks, you've got a number of reasons to stick with them. Cutting your winners can prove to be a disastrous mistake if a company still has more room to grow. Selling stocks you bought just three months ago can cost you a fortune in taxes. And if future growth prospects on a particular stock justify its higher earnings multiples, then you may well conclude that what you own still gives you better value than alternatives.

If you don't own them, though, I think the question you have to ask yourself is this: Which stocks do you think offer you the best value right now? Despite the strong returns that most stocks enjoyed during the quarter, some low P/E stocks, such as Chevron (NYSE:CVX) and GameStop (NYSE:GME), actually lost ground. But with that subpar performance now in the past, what's important is whether they'll pick themselves off the floor and outperform their higher-priced peers going forward.

Focusing too much on past victories -- or missed opportunities -- can distract you from the true task at hand: picking the stocks that will be tomorrow's winners.

Value for now
As pleasant as recent gains have been for stock investors -- especially those who suffered big losses last year -- don't take the recent rally as an opportunity to rest on your laurels. Instead, recognize that you constantly have new chances to prove your investing prowess. Rather than letting inertia keep you in the same stocks for months or years, making an affirmative choice to buy and hold the best stocks will bear the most fruit over the long run.

Read more on finding the best values in today's challenging stock markets:

• How did bonds ever beat stocks?
• Don't fall into these value traps.
• Don't sell that stock!