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.

Every day, Nasdaq.com publishes a list of stocks whose shares have just hit new 52-week highs. And every day, investors read the list and tremble -- some with greed, others with terror. In our Motley Fool CAPS investing community, these top stocks usually enjoy favorable ratings, since everyone loves a winner. But what should you do when some of CAPS' smartest investors pan one of these hot stocks?

For starters, consider using the "52 week high" list as a starting point for further research. Stocks can rise for many reasons, but a little help from Motley Fool CAPS can make it easier to figure out how worthy those reasons are. Let's see what the more than 120,000 stock gurus (and counting) in CAPS have to say about the list's latest contenders:

Companies are selected from the "52 Week High/Low" lists published on Nasdaq.com on Saturday of last week. Year-ago and recent prices provided by Yahoo! Finance. CAPS ratings from Motley Fool CAPS.

"Everybody loves a winner"
For the first time in a long time, we get to put this truism to the test today. As markets finally took a turn for the better last week, a very few stocks managed to post year-long highs. And yet, of the five companies noted above, Fools seem to think only one has a chance of continuing to beat the market: Motley Fool Rule Breakers recommendation American Science & Engineering.

As it happens, I've written about AS&E myself, in articles by turns complimentary, castigating, and contemplative. Today, we'll open the mike to a few AS&E skeptics -- brave Fools who dare to wager their reputations by voting against a winner. Let's give 'em a chance to make ...

The bear case against American Science & Engineering
We begin with SwordAgain, who first gave AS&E the thumbs-down in October, then found his opinions reconfirmed when the company reported earnings last month. SwordAgain's take on the report: "Marginal product growth. Subject to declining margins and lowered expectations. Growing competition." For the record, AS&E's competitors range from near-unknowns such as OSI Systems, all the way up to giants of industry like L-3 Communications (NYSE:LLL) and General Electric (NYSE:GE).

Nor are competitors the only threat to AS&E. In fmahnke's view, the firm's customers pose problems of their own: "Trades at too high of a P?E given current growth. Security related and gov't related defense spending face headwinds in Obama administration with massive debt levell."

Finally, a few words of warning from CAPS All-Star rebelseeker, who sees in AS&E's recent performance little more than a: "Speculative runup in stock price [to a] PE 36." As of this writing, AS&E's actually clocking in with an even higher 41 P/E. rebelseeker also critiques the firm's declining "stock holders equity" and rising "43% increase in inventory."

This Fool's opinion
I've shared many of these same concerns myself over recent quarters. But unlike SwordAgain, I thought the company's Q2 earnings report allayed more concerns that it raised.

Profit margins are on the upswing at AS&E, with net earnings close behind. Meanwhile, the negative free cash flow that I've criticized in the past is, well, in the past. AS&E's back in the  black, free cash flow-wise. And with its backlog of orders continuing to expand faster than sales, I see little reason to worry about either the inventory increase (which may be necessary in order to fulfill all the orders coming in) or the firm's rather lofty P/E.

With free cash flow swelling, AS&E's P/E probably isn't the best measure of the company's value. Judged by its FCF, the stock currently trades for a mere multiple of 21 -- even less than that, if you net out the cash to arrive at the enterprise value. While I admit I'm little leery of paying even this price for analysts' expected 15% long-term growth rate, those analysts' repeated and proven cluelessness in this regard gives me some reassurance. Whether AS&E's long-term growth rate winds up higher or lower, I'm certain at least that it won't be 15%.

Time to chime in
Of course, the aim of this column isn't just to tell you what I think about American Science & Engineering -- or even what other CAPS members are saying. We really want to hear your thoughts. Click on over to Motley Fool CAPS and tell us what you think.

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