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?

Judging from the ratings they're handing out, though, it appears CAPS members aren't too worried by that prospect this week. And for the most part, I agree. With P/E ratios ranging from a low of 7 to a high of 16, the stocks of SeaDrill Limited, Atwood Oceanics, and Western Union really don't look very expensive today -- yes, even at their "52-week highs."

SandRidge Energy is a different matter, unprofitable today, and priced at 33 times earnings estimates for this year. But even here, there may be more than meets the eye. CAPS member joeboy4545 recently argued that whatever the company's income statement may say, "SandRidge's proven energy reserves are worth about $5 a share, and its unproven reserves are worth an additional $8 a share. Even if half of the unproven resources fail to materialize, then the net asset value (NAV) for all of SandRidge is about $9" -- suggesting even SandRidge may not be quite as overvalued as it seems.

Last and least, we come to Herbalife. Organized similarly to the structure of a Medifast (NYSE: MED), Pre-Paid Legal (NYSE: PPD), or Amway, Herbalife seems to suffer from the stigma many investors attach to multilevel marketers. Of course, I'm only guessing here -- but how else would you explain the fact that a company with an entirely reasonable P/E score (17), a company that just trounced Wall Street estimates and booked a 46% increase in quarterly profit, receives only a single "star" from CAPS members?

"How else" indeed? Fortunately, there's no need to guess about this one at all. Let's go straight to the source and find out what the Fools, who've given Herbalife its rating, think about the stock.

The bear case against Herbalife
The disdain investors in which hold Herbalife is practically palpable. The most recent negative comment, from CAPS All-Star Beorn10, dismisses the company as "Politically correct snake oil salesmen preying on the overweight and weak minded individual."

CAPS member PdoBear, has castigated Herbalife management for paying themselves well "while owning few shares. Pyramid like structure with little to prevent copycatting in their new marketing target -- China."

That's not an uncommon complaint, either. All-Star investor amteague777 predicts that, "it's only a matter of time befor they're 'herbal' supplements become the next lawsuit. None of the top execs are major direct holders, which concerns me, especially with their hefty salaries."

And yes, just as you might expect of the folks sitting atop a pyramid, Herbalife's head honchos do make out pretty well. Company President Desmond Walsh took in $1.1 million last year. CEO Michael Johnson pulled down close to $9 million in cash and stock compensation.

The over/under on Herbalife
So ... overhyped product, overpaid executives ... But the real question is whether the stock is over-priced. I think it is, but perhaps not as badly as some bears might believe.

Consider: At 17 times trailing earnings, Herbalife does seem a bit richly valued for the 12% long-term growth that analysts predict for the company. On the other hand, Herbalife generated $312 million in free cash flow last year -- 8% more than reported GAAP earnings. It's also grown both GAAP earnings, and free cash flow at a pretty steady clip over the last five years -- and beaten analyst projections with a stick in each of the past four quarters.

Foolish takeaway
I'm not a fan of multilevel marketing. I'm not even a fan of Herbalife itself. (Fact is, my first exposure to the company came about 10 years ago, when I saw a company flyer pasted to a telephone pole along the streets of Moscow. I thought it was a joke -- due to the lack of a letter "H" in the Russian alphabet, the company's name read "Gerbil-Life!")

All that being said, at a valuation of under 15 times free cash flow, with a dividend of 1.3%, growth projected at 12%, and growth performance consistently exceeding growth projections, I'm not convinced Herbalife really is destined to fall.

But hey, that's just my opinion. I'm still willing to be convinced. If you can come up with more convincing arguments against the company, than the several listed above -- have at it! Click over to Motley Fool CAPS now, and sound the alarm.