"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 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 plastic shoes have to do with chemotherapy? What do either of these things have in common with automotive brakes and transmissions? The answer to both questions is this: Companies behind these products are some of the hottest stocks on the Street.
Over the past year, shares of clog kingpin Crocs have tripled in value as the company clawed its way back to respectability – and, more importantly, profitability. You can count CAPS member BrodieMan720 among those who've been converted to the Crocs cause: "It seems like management's a little bit better on track. Whatever debt they have isn't that big of a deal because they have the cash from operating activities to wipe it out if they needed to."
Delcath Systems hasn't done as well as Crocs; it's "only" doubled. But it's got a couple of irons in the fire at the FDA that could drive the stock higher. According to CAPS member dtannen, "Delcath should get approval for melanoma mid-2011. The opportunity is much bigger for its PHP system though."
These stocks' one-star and two-star ratings, respectively, on CAPS tell us that not everyone is convinced the stocks will maintain momentum. While I actually think Crocs, at least, looks not unreasonably priced today, I do agree that caution is appropriate at these prices levels. What concerns me is the strong optimism investors are expressing about another of these 52-week doublers -- Wabco.
The bull case for Wabco Holdings
Never heard of Wabco? Then perhaps a short history lesson is in order. In 2007, a conglomerate by the name of American Standard decided it could best do right by its shareholders by breaking into three parts. The bulk of the company renamed itself Trane and began trading under that name. Private equity got the company's toilets (appropriately?) What was left, the firm's vehicle controls division, became Wabco.
CAPS member luvnlifelake08 agrees, seeing particular success in Asia and Europe and predicting the demand for its braking and transmission systems will "weather the American economy as it opens new plants in India."
Given the mind-set of investors these days -- being fixated on the rapid revival of Ford
The clutch sticks a bit
If I had to guess, I'd say the thing that's really attracting investors to Wabco is that earlier this year the company was forced to cough up a $400 million indemnification payment to Trane as part of a European Union prosecution of the latter company. The payout has Wabco looking unprofitable today, but savvy investors know that Wabco is appealing its obligation to indemnify, and may get some or all of its money back.
Buying in anticipation of that good news, and hoping for a pop when it arrives, may seem a good idea, but to my Foolish eye, it misses the point. Seems to me, quite apart from whether Wabco ultimately pays for American Standard's sins, Wabco itself just isn't that bright of an investment.
Consider: Over the past five years, Wabco's free cash flow averaged just over $100 million annually. The indemnity payment plunged the company deeply into the red, but even without it, and even if the company gets its money back, I ask you: Is a company that makes $100 million in an average year really profitable enough to deserve a $3.2 billion market cap? Put another way, does 15% projected long-term growth justify paying 32 times free cash flow?
Time to chime in
I think the company's overpriced, a dud of an investment, doomed to fall back to earth. But maybe you think the company will grow faster than Wall Street expects, or that the free cash flow doesn't tell the whole story here. Maybe you think someone will acquire the company outright, and pay a premium for Wabco.
Whatever your views of Wabco, you can tell us about them right here, on Motley Fool CAPS.
Ford Motor is a Motley Fool Stock Advisor pick. 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. 623 out of more than 170,000 members. The Fool has a disclosure policy.
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