Rocket Stock or Dud?

"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. Below I list a few stocks that may have done just that. Stocks that, according to the smart folks at finviz.com, have more than doubled since the beginning of this year, and just might be ripe to fall back to earth.

Companies are selected by screening for 100% and higher price appreciation year-to-date on finviz.com. Five stars = highest possible CAPS rating; one star = lowest. Current pricing provided by Yahoo! Finance. CAPS ratings from Motley Fool CAPS.

Each of these stocks has reaped huge rewards this year, but if you ask the 145,000 investors working odds on Motley Fool CAPS, it's just about time to cash in the ol' chips and leave the table. 100% profits are nothing to sneeze at, you know. No need to get greedy ... or is there?

One of the darlingest of the tech darlings back during the Internet boom, Level 3 quickly fell on hard times when the bottom fell out of the telecom market. By late last year, the stock had fallen into "penny stock" territory, yet this year, a lot of Fools are betting on a revival. Why?

The bull case for Level 3 Communications
CAPS All-Star jrkchicago began arguing a few months ago that: "Demand for data transmission is growing exponentially and the major telcos are offering the public an all-you-can-eat buffet for a fixed price. The populace is gorging on this buffet with no signs of putting down their forks. LVLT owns the pipes the major telcos need to expand. It is just a matter of time ..."

As for what happens over that time, Level 3 optimists are happily agnostic. vikingzskillz, for one, believes: "Level 3 is a possible takeover target." But even if no one buys the company, there's still a need to: "transfer huge amounts of information and with growing demand of smartphones and more people wanting high speed Internet, LVLT will be rewarded with the infrucstructure they possess."

valuegal agrees: "The fiber assets are worth much more, either management will exploit them or someone else will buy them and put them to use."

So let me get this straight: Heads Level 3 wins, and tails nobody loses? This stock could reward investors with a premium if it gets bought out, or with profits as it recovers as a stand-alone company? It almost sounds too good to be true ...

And there's a reason for that
It is too good to be true. Let's consider the buyout scenario first. Level 3 sells for 3.5 times book value today. Which may not sound like a lot, but it's more than twice the valuation on rival company AT&T (NYSE:T), and a 60% premium over what shares of Verizon (NYSE:VZ) fetch. And while I'm not necessarily saying these telecom majors aren't interested in buying Level 3 for its assets ... I am saying that they'd be crazy to do so at today's prices.

As for Level 3's attractiveness as a stand-alone company, well, it isn't.

Attractive, that is. Unprofitable and carrying more than $5.8 billion in net debt (for comparison, the company's entire market cap is only $2.4 billion), about the only valuation argument I can make in its favor is the fact that Level 3 seems to be generating more free cash flow in recent years – but even here, the stock sells for 34 times free cash flow. Considering that most analysts expect Level 3's profits to turn back down and decline pretty steadily over the next five years, I'm forced to conclude: This stock's no rocket. It's a dud.

Time to chime in
To me. You, however, are welcome to hold a contrary view. Heck, if you do see greater prospects for Level 3 than the ones I've outlined, we'd love to hear your arguments. At the Motley Fool, you'll always have a place to state your case.

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