Drink In These 5 Top Stocks

Whether it's the corporate lunchroom, your cubicle, or the local watering hole after work, there are regular places we gather to discuss news, sports, or -- if you're like us -- stocks. Here at Motley Fool CAPS, we gather around the virtual water cooler daily to rate stocks and delve into their merits as investments.

Our 140,000-strong CAPS community -- where members give the thumbs-up or thumbs-down to about 5,300 stocks -- seeks businesses it thinks will outperform the market. Below, we'll take a look at some of the most popular stocks in the CAPS universe and examine whether you think they'll continue their winning ways.

A tall drink of water
Before last week, you might have figured the market was overheating because the early part of the recent run-up was fueled by low-quality stocks. But as companies reported earnings, they were beating both last year's results and analyst estimates, suggesting that the economy really was on the mend. Of course, last year was a horrible year, so going up against those easy comparisons was no big feat, and analysts were just a pessimistic bunch. Much of the gains being achieved were because of cost-cutting, not because revenues were on the rise.

If you had figured that out, you might have thought it would be a good time to short the market, perhaps using exchange-traded funds such as UltraShares S&P 500 ProShares. This ETF seeks results that are twice the inverse of the daily performance of the S&P 500, but it's not buying or shorting the underlying stocks in the index, such as stalwarts like Procter & Gamble (NYSE:PG) or recently added MetroPCS Communications (NYSE:PCS). Instead, using a complex system of financial instruments such as swaps and futures to achieve the negative return, when the index moves 10% in one direction or the other, it's looking to double that. Except it doesn't.

A recent study shows that because of their need to increase the bet on the daily index performance, ultra-short ETFs actually increase their "tracking error" and end up underperforming on a longer-term basis. For example, the S&P 500 lost almost 34% last year, suggesting that the corresponding ultra-short ETF should have an implied return approaching 68%. However, because of the problem the study pointed out, it only beat the index by 22%.

That kind of outperformance is nothing to sneeze at, but this fund is looking to double the movements of the market, so you're accepting much greater risk for lower returns. No doubt, that's just one of the reasons Direxion Funds, one of the leading names in leveraged ETFs, says investors shouldn't hold these funds for more than a day.

There are benefits to investing in an inverse ETF. You can pursue a bearish strategy or hedge long positions without having to actually go short any stocks. And because an investment in an inverse fund is considered a long position, you can "short" the market (or a subset of it) in retirement accounts that wouldn't otherwise let an investor actually take a short position.

But CAPS member ShortUltras is no fan of ultra ETFs because of their need to rebalance daily, although jragandau writes that if there's a severe correction, even if the fund doesn't achieve its goal of getting double the inverse of performance, it would still be a profitable bet:

For those that missed the first step down in the Decade of Decline the SDS shares will be a stellar performer as stage 2 begins. The current rise in the stock market since March 2 is a teaser but the real direction is the … deep south. Not only for stocks but also bonds, commodities, real estate, debt instruments and money markets. Best place for your money is not invested or short all the investments that have historically paid a return. [G]ood time to consider reentering the market for financial assets is 2018.

I find these inverse plays too risky to venture into, one way or the other, and I won't be going long -- or short -- in my CAPS portfolio on any of them. How about you?

Gather 'round
With so many good opinions about today's top companies, why not grab a pointy paper cup from the dispenser and join us at the Motley Fool CAPS water cooler? Your input can help guide other investors to stocks with bright prospects. Read a company's financial reports, scrutinize key data and charts, and examine the comments your fellow investors have made -- all from a stock's CAPS page.

Sign up today for the completely free service and let us hear what you have to say about the great and almost-great companies that interest you.