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.

When a stock hits a new 52-week high, it's only natural to wonder whether "this time" is "the last time" -- whether there's nowhere left to go but down. And when you examine the valuations on the stock's making the list this week, this does seem a question worth asking.

Consider: Right now, Kinder Morgan is selling for nearly 33 times next year's earnings. Provident, 17.5 times forward earnings. Philip Morris and Dow Chemical -- 12.5 and 11.5 times, respectively. The curious thing, though, is that their apparently pricey valuations notwithstanding, all four of these stocks still enjoy widespread support from the 170,000 (and counting) investors on CAPS. Meanwhile, the stock with arguably the lowest valuation on the list is the one investors like least.

The bear case against International Paper
Selling for just 9x forward earnings, and paying a respectable 2.5% dividend, International Paper scores just two stars on CAPS. What this means, quite simply, is that whether or not the stock actually loses value in the future, Fool members generally agree that International Paper is likely to underperform the S&P 500 going forward. But why?

If you ask CAPS member smartdanny, the answer is one part price ("this stock is overbought") and one part fundamentals ("the company is in a shrinking industry").

All-Star investor wstimson adds that on top of all that, International Paper has "deteriorating fundamentals." The most instructive comment of all comes from CAPS member Botterbein, who gives us a first-person account of what's wrong with International Paper: "I work for a competitor of IP. The entire paper industry is sinking quick [and] ripe for consolidation."

But doesn't that mean ... ?
Now, comments like that last one might have you thinking about the possibility that International Paper could be a potential buyout -- and it could. Stranger things have happened. Still, I have to say that when I survey the industry, there aren't a lot of companies out there that look to have the financial wherewithal to do much "consolidating."

International Paper itself, the giant of the industry with $25.2 billion in annual sales, is already carrying a $6.6 billion net debt load. The distant No. 2 Weyerhauser (NYSE: WY) is in nearly as bad shape, striving to support a $3.5 billion net debt load on annual sales that are just a fraction of what IP brings in. Meanwhile, new-tech companies like Adobe (Nasdaq: ADBE), with their paperless PDF products, are doing their best to shred the paper industry's business model, along with its revenue streams.

Foolish takeaway
For now, International Paper seems to be weathering the storm. While not as profitable as in years past, the company did still earn $644 million last year -- and generated $856 million in free cash flow. Whatever next year's earnings ultimately turn out to be, and whatever number this generates for the stock's forward P/E ratio, the fact remains that today, this means that IP sells today for near-20x the profits it actually earned last year -- and an enterprise value-to-free cash flow ratio of 22x. For a company that most investors believe will struggle to achieve even 2.5% long-term earnings growth, these valuations seem a bit ... optimistic.

But hey, that's just my opinion. If you'd like to cancel it out with a reason or three (or 11, or 12) why International Paper actually deserves its premium price, then here's your chance to set me straight. Click over to Motley Fool CAPS now, and sound off.