Get Ready for the Fall

"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, WSJ.com publishes a list of stocks whose shares have just hit new 52-week highs. And every day, investors read the list and tremble -- some with greed, others with terror. On our Motley Fool CAPS investing community, these top stocks usually enjoy favorable ratings, since everyone loves a winner.

But not always ...

Companies are selected from the "New Highs & Lows" lists published on WSJ.com on Friday last week. 52-week low and recent price provided by Yahoo! Finance. CAPS ratings from Motley Fool CAPS.

July's sudden surge on the S&P pushed each of these stocks to new 52-week highs. But if truth be told, investors are beginning to fear that the market's rally might be a bit overdone. No less an investor than Warren Buffett says he's yet to see all these green shoots everyone's been talking about -- and at CAPS, our community of lay investors appears to agree.

Out of the five shooting stars named above, only one gets an above average rating from CAPS members. Let's find out why, as we investigate ...

The bull case for Infosys
As far back as October of '08, sunnyman100 had Infosys pegged as "the top leading Indian Software outsourcing firm with positive cash flows and reserves. It has a ubiquitous presence in the Indian Software arena, attracts top talent, and is the company of choice across the world for their IT and Application outsourcing decisions." And earlier this year, hilofarmgal gave Infosys the thumbs-up as well, citing its "low debt, high profit, sweet spot for technology stimulus."

CAPS All-Star investor FinancialPeace agrees. Writing in February: "This stock has weathered the economic downturn nicely, lost some of it's competition [I think that's a reference to you, Mahindra Satyam (NYSE:SAY)] and is again ready to run. One, if not the best IT company in the world. IT outsourcing is still a relatively new trend, I think this stock could really take off."

I agree. Longtime readers of the Fool will recall that I've liked Infosys in the past, but always had one big, nagging concern about the company. To wit: It has historically reported earnings far in excess of the amount of free cash flow it actually produced.

Early last year, I had the opportunity to quiz Infosys CFO V. Balakrishnan about this. What he told me at the time was that, unlike Western competitors such as Accenture (NYSE:ACN) and IBM (NYSE:IBM) which operated largely in developed economies, Infosys has historically had to contend with a relatively undeveloped infrastructure in India -- and consequently, has needed to sink a lot of its cash into capital expenditures to develop it.

But checking back in on the company today, it appears that these investments have paid off. Over the past four quarters Infosys is finally generating free cash flow almost on par with its reported profit -- $1.2 billion of free cash versus $1.3 billion accounting profit, to be precise.

And while this still leaves the stock sporting a relatively high valuation at 19 times earnings, this may not be too extreme in light of the company's projected 16% long-term growth rate.  Add to that its extremely clean balance sheet, which boasts $2.5 billion in cash and equivalents, and no long-term debt. That cash means Infosys trades at an enterprise value-to-free cash ratio that's even cheaper, just 18 times.

In short, while Infosys is certainly not the cheapest stock I've ever seen, its valuation is at least defensible. I see no reason why this stock must fall.

Time to chime in
But hey, that's just my opinion. And the aim of this column isn't just to tell you what I think about Infosys -- or for that matter, even what our CAPS members think. What we really want to know is what you think about the company. If you've got an opinion, we've got a place to tell people about it.

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