Rocket Stock or Dud?

The bigger they are, the harder they (might) fall.

Rich Smith
Rich Smith
Dec 6, 2010 at 12:00AM

"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, have doubled (or nearly so) over the past year, and just might be ripe to fall back to earth.



Recent Price

CAPS Rating
(out of 5):

Baidu (Nasdaq: BIDU) $109.23 **
Netflix (Nasdaq: NFLX) $185.45 **
TriQuint Semiconductor (Nasdaq: TQNT) $12.72 ****

Companies are selected by screening for 100% and higher intraday price appreciation over the last 12 months on Five stars = highest possible CAPS rating; one star = lowest. Current pricing provided by Yahoo! Finance. CAPS ratings from Motley Fool CAPS.

Question: What does Chinese Internet search have to do with supplying DVD rentals by mail and streaming entertainment? What do either of these things have in common with semiconductors? 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 Chinese Internet star Baidu have gained well over 150%, while Netflix has more than doubled. Yet if you ask some Fools, they're both still underpriced. CAPS member GusMax, for example, thinks "a governmental endorsement" makes Baidu a sure winner. "When the Chinese Government blocks its citizens from viewing a website (which it does often), where do they send you? They send you to" Netflix may lack a government sponsor, but GusMax thinks this one is also a winner because "this is the absolute king of streaming. They've got their hand in most new home entertainment systems (Blu-Ray players, gaming consoles, sound systems) and have embraced portable streaming."

Yet with Netflix selling for a price-to-earnings ratio of 70, and Baidu commanding a stock price more than 90 times trailing earnings, it's no surprise not all Fools share GusMax's enthusiasm. It's no surprise that these stellar companies -- because of their high prices -- are only rated two stars on CAPS. But what about the third stock on today's list? At a P/E of only 12.4, and pegged for 17.5% long-term earnings growth, TriQuint Semiconductor sure looks cheaper than Netflix or Baidu. But is that enough to justifying buying the stock?

The bull case for TriQuint Semiconductor
Let's start off with a quick introduction to TriQuint, courtesy of the Fool's own TMFBreakerJava, who wrote back in March: "This maker of RF components has strategic relationships with the major hand set makers other than Nokia. They have benefitted from the unexpected expansion of wireless LAN technology to smart phones. ... Their other business segments consist of wireless LAN itself and also some work for USDOD (about 10% of their business), but handsets represent two thirds of their sales and the rapid expansion of wireless LAN to cell phones should drive rapid growth for a number of years to come."

CAPS member rdwolf34 agrees that the company looks like a "very good 4G, 3G+, etc. play for Smartphones etc."

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As CAPS member 4thsuper pointed out last month, TriQuint is proving to be just that: "Earnings up 170% over the same quarter last year. Sales up 37% over sales quarter last year. Beat earnings estimates by 3.9%. Worth $18.00."

Squinting at TriQuint
To put these numbers in context, 37% sales growth is about twice the amount of growth either Intel (Nasdaq: INTC) or Advanced Micro Devices (NYSE: AMD) recorded last quarter. It's on par with the pace set by smartphone supplier Skyworks Solutions (Nasdaq: SWKS), but while Skyworks' earnings declined in Q3, TriQuint's profits nearly doubled. Yet, as good as these two numbers look, TriQuint's got another number that concerns me somewhat: its free cash flow.

Remember how I said it was TriQuint's low P/E that set it apart from Baidu and Netflix in the it's-gone-up-a-lot-but-is-it-still-cheap contest? Well, as it turns out, TriQuint owes its low P/E ratio to the fact that between fiscal 2009 and fiscal 2010, the company somehow managed to expand the amount of GAAP "profits" it reports more than 10 times in size. While much of this increase looks real, a consequence of strong sales growth dropping lots of extra money to the bottom line, TriQuint owes a good 40% or so of its net "profits" to a massive $73 million tax credit it was able to claim last quarter. (That being the quarter that so impressed 4thsuper in the note up above.)

From a free cash flow perspective, though, the company really only generated about $25 million in cash profits over the past year, or about 85% less than its income statement would suggest.

Foolish final thought
Valuing the company on its free cash flow, I view TriQuint not as a stock with a "12.4 P/E," but as a company selling for 80 times the amount of cash it was able to generate in an exceptionally good year. And I wonder: How expensive would the company look in an average year? How likely is it that the stock is worth 80 times free cash flow, even if TriQuint succeeds in growing at the 17.5% annual pace Wall Street has it pegged for?

The answer I keep coming up with is: Not very. And that's why I'm calling this rocket stock a dud.

But, hey, feel free to disagree. If you think TriQuint deserves a second look, click over to Motley Fool CAPS now, and tell me why I'm wrong.