Rocket Stock or Dud?

Editor's Note: This article was written before Tuesday's announced merger of Holly and Frontier. Check back Wednesday on Fool.com for our analysis. 

"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 does discount oil-refining have to do with Internet equipment-making? What do either of these activities have in common with the retail sale of yoga-clothing? Answer: the companies behind these endeavors boast some of the hottest stocks on the market today.

Over the past year, shares of oil refiner Frontier Oil have climbed 110% in value. Network equipment maker F5 is up 120%, while li'l Lululemon has gone on to even bigger and better things -- namely, a 182% gain.

[Pause for applause.]
Now that the stocks have taken their bow, however, it's time to ask the important question: They've all done well over the past year, but which of these companies will excel in 2011? On CAPS, All-Star investor Gordogato makes the case for Lulu -- "a small company makes apparel that appeals to an upscale demographic ... They have a great product for a specific market of customers and a lot of room to grow," while fellow All-Star CTB1000 prefers F5. Judging from the recent blockbuster earnings report it put out, CTB1000 thinks F5 "will continue to grow at a fast pace due to the demands of the Internet."

But good as these individual arguments sound, the broader consensus on CAPS is that it will be hard for three-starred F5 (and even harder for one-starred Lulu) to keep outperforming the market from their current, high prices. If you're looking for a better bet, according to the 170,000 investors who make up Motley Fool CAPS, you really want to trek out west and explore five-starred Frontier:

The bull case for Frontier Oil
What's so great about Frontier Oil, you ask? CAPS member Cressida sees "demand huge" for the company's refined oil products. The company's both "profitable and capable."

And Cressida's not the only one that thinks so. Early last year, CAPS member moneymaverick2 pointed out that as a result of refiners "cutting back on refining capacity ... refining margins have seen the worst of it," and profits were bound to improve.

Fast forward a year, and it seems a lot of folks are starting to get interested. Last week, I highlighted RBC Capital's argument that access to cheap "West Texas Intermediate" crude oil was bound to improve profits at oil refiners like Valero (NYSE: VLO) and Western Refining (NYSE: WNR). No sooner had I done so than out came the Wall Street Journal itself to add two more names to our shopping list -- ConocoPhillips (NYSE: COP), said to be reaping big profits from refining cheap WTI oil, Enterprise Product Partners (NYSE: EPD), which transports the stuff, and ... Frontier Oil itself. According to Deutsche Bank, while 'most everyone seems to be benefitting from this bonanza, no one's getting richer, faster, than Frontier Oil.

The Journal: Wall Street's contrarian indicator of record?
But here's the thing: Once a story has been reported in the Journal, the cat is pretty much out of the proverbial bag. Once everyone knows the good news, you have to ask yourself whether the good news is baked into the stock price? And in Frontier Oil's case, I rather suspect it is. Consider: Right now, Frontier's not looking so hot. It's got negative earnings for the past 12 months, negative free cash flow for the past 18 months (combined). Even if we assume the company's now at its nadir, and has "nowhere to go but up," how far can it go?

Looking over the company's results for the past several years, and focusing on the ones where things got really good -- the period from 2004-2009 -- I find that Frontier was averaging about $171.5 million in annual free cash flow over this period. But, if you crunch the numbers on those cash earnings, you'll see that the stock today is valued at 17-times this free cash flow.

Foolish takeaway
When you consider that Frontier has to climb out of a hole first to reach its profitability of yesteryear, and that once it gets there, Wall Street is projecting only 14.5% annual growth over the next five years, I have to say the resulting ratio -- 17x FCF / 14.5% growth -- looks a little pricey. In short, while the company's rocket-ride to 110% gains over the past year appears justified, I very much fear that at current prices, the stock's priced for future dud-hood.

Disagree? Hey, it's a free country. But won't you take a moment to tell us why? If you think Frontier still has fuel in the tank, click over to Motley Fool CAPS now, and tell us why.