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 upward.

Problem is, if the price goes up too much, even a great company can turn into a lousy investment. Below I list a few stocks that may have done just that. Stocks that, according to the smart folks at finviz.com, have more than doubled since the beginning of this year, and just might be ripe to fall back to earth.

Companies are selected by screening for 100% and higher price appreciation year-to-date on finviz.com. Five stars = highest possible CAPS rating; one star = lowest. Current pricing provided by Yahoo! Finance. CAPS ratings from Motley Fool CAPS.

Each of these stocks has enjoyed remarkable gains over the past five months. But if you ask the 130,000 (and counting) investors who make up Motley Fool CAPS, not all of them deserve those gains. One stock in particular stands out as particularly lacking in investor love. Let's find out why, as we examine ...

The bear case against XL Capital
As far back as a year ago, CAPS All-Star shop1 criticized XL for reporting: "a dramatic decrease in Q1 net income, down from $562.5 million to $244.4 million. The company's investment portfolio lost $1.4 billion and its insurance divisions profit was squeezed as more claims were paid & insurance premiums were decreased due to competition."

After seeing the firm's stock leap from $2.82 to $4.55 in early February 2009, Fellow CAPS member cbwang888 characterized the firm's "60% jump in a day" earlier this year as "short covering." And indeed, the stock did fall right back down in short order ... but has since recovered to rise another 96% beyond that supposed "short covering" rally.

That rise sure sounds like good news -- but some Fools remain unconvinced. Yet another of our All-Star investors, Smith568, looks at the stock's continued rise and concludes only that XL is a: "Weak company... not worth this price."

So what is XL, really? Is it a real rocket stock, or a dud that doesn't know it yet? I see several reasons to be suspicious of XL Capital. First, while the stock has a decent combined ratio of 95.7%, that number is up sharply from where it held over the past couple of years. I also cannot help but notice that the firm's expense ratio (one component of the combined ratio) has risen for three years straight.

Now, this is not an issue isolated to XL. Montpelier Re (NYSE:MRH) is showing similar trends, and to a lesser extent so is insurance industry standard Berkshire Hathaway (NYSE:BRK-B). But that still leaves us with two undeniable facts that argue against investing in XL:

• First, just because bad things are happening to everybody (generally), doesn't mean you should ignore them happening to anybody (in particular, XL).
• Second, XL's combined ratio is clearly the worst of the three insurers named, begging the question: Why buy it at all when there are better choices available?

Time to chime in
Of course, the aim of this column isn't to tell you what I think about XL Capital. On this question, there are far wiser Fools to whom you should listen first. In fact, perhaps you're the one who should be telling us about the company. If you've got an opinion, we've got a place to voice it.

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