Which Stock Falls First?

"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, finviz.com publishes a list of stocks whose shares have just hit new 52-week highs. Every day, investors read the list and tremble -- some with greed, others with terror. Within our Motley Fool CAPS investing community, these top stocks generally enjoy favorable ratings, since everyone loves a winner ... but not always:

Companies selected by screening for new 52-week highs hit on the Thursday before publication. Low and recent price provided by Yahoo! Finance. CAPS ratings from Motley Fool CAPS.

Whenever a stock hits new 52-week highs, investors naturally wonder how long the good news can keep coming. Still, CAPS members seem unconcerned about the valuations on the first two stocks on our list. At 13 times earnings ExxonMobil simply doesn't look all that expensive in light of its projected 12% long-term earnings growth. Verizon's pricier, but I suspect more investors own it for its generous 5.5% dividend payout than because of an expectation Verizon's going to tear up the track, growth-wise.

Sirius? You know all about this one -- some folks hate it, others love it. Personally, I'm of the opinion that Sirius' emergence into free cash flow-positivity finally makes it worthy of attention from serious investors. (Sirius' latest announcement of a partnership with BMW is likely only going to help with that.)

Given that, you might think I'd be similarly positive on Molycorp, seeing as it just inked a deal to help Hitachi Metals produce rare earth magnets. Well, I'm not -- and I'm not alone. Molycorp is the weakest-rated stock on this week's list, and today we're going to take a look at why.

The bear case against Molycorp
Bulls will tell you that Molycorp's got great potential in a world swiftly running low on rare earth metals supplies, but CAPS All-Star Lordrobot says that's literally a bunch of bull:

This is one of the truly great cons of all time because rare earth metals are in fact not rare at all. Its just a name. But because only China will do this work for such a low margin, 90% is mined in China and about 10% in South Africa. It is not fun, it is not profitable. It basically sucks as a business.

CAPS member iversonj88 further worries that: "China is holding way too much sway over these companies as they decide what to do with their enormous store of these metals. ... as the Chinese realize its ok to sell off some of these precious resources and still have plenty left over themselves, they are going to drastically increase supply in this market over time."

CAPS member adamhu is more succinct: "100x expected sales? are you kidding me???"

But in fact, Mr. Market is not kidding you. Molycorp really does sell for 134 times this year's expected revenues, and 70 times next year's. It also:

• Costs nearly 8 times book value (admittedly, only half the cost of the even riskier Rare Element Resources (NYSE: REE), which costs 17 times book).
• Has neither profits nor positive cash flow.
• Has attracted so much interest from professional bears that 10% of its float is currently sold short.

Now maybe these pie-in-the-sky valuations would have some basis if rare earths were truly rare, and Molycorp was the only company mining them, but it's not. Fact is, in addition to the Chinese companies our CAPS members mention, this is also an area of business in which mining giant Freeport-McMoRan (NYSE: FCX) participates. (By the way, Freeport is both profitable and solidly free cash flow-positive.)

In contrast, Molycorp is described as a "development stage company" that only "expects to produce at a rate of approximately 20,000 metric tons of REO equivalent per year and intends to offer a range of rare earth products, including high-purity oxides, metals, alloys, and permanent magnets." [Emphasis added.]

Foolish takeaway
As fellow Fool Travis Hoium recently pointed out, 20,000 tons of production would, at current prices and mix, give Molycorp only $292 million in annual sales -- leaving the stock still valued at 13 times sales, and still with no guarantee it would earn profits on those sales. All of which explains why, out of all the stocks on today's list, Molycorp gets my vote as the stock most likely to fall first.

Think I'm wrong? Go to Motley Fool CAPS, and place your bets now.