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?

Reviewing the five stocks making this week's list of 52-week high-hitters, I'd say the safest choice today is Norfolk Southern, which boasts a 17 P/E ratio -- quite reasonable in light of its 14% projected growth rate and 2.5% dividend yield. In contrast, Kellogg looks less attractive, with a dividend yield not much greater than Norfolk Southern's, a growth rate considerably slower -- and the risk of rising commodity prices threatening its profit margin.

Even greater risk, I think, faces investors in Duke and Exelon. From a valuation perspective, even with the best dividend yield of the bunch (5.3%), Duke's 18 P/E looks aggressive in light of the company's low 5% rate of earnings growth. Exelon, with a smaller dividend and the potential for negative growth over the next five years, also looks risky. When you add recent events in Japan to the mix, I also see the potential for tighter regulation of nuclear power plant operators and higher costs for doing business. In France, for example, where 80% of electricity is generated from nuclear power, the green movement is now calling for the shutdown of all nuclear power plants. (Both Duke and Exelon operate nuclear plants in the U.S.)

Be that as it may, and my opinions notwithstanding, the fact is that none of these four stocks are the ones that worry CAPS members most. No, if there's one stock out there that most investors expect to decline in value before all others, it's the lowest-ranked stock on the list. Read on, as we find out why the single stock investors most love to hate is ...

J.C. Penney
But what is it, exactly, that CAPS members so dislike about J.C. Penney? CAPS All-Star kristm sums it up in two words: "granny panties." Scoffs kristm: "JC Penney is associated with granny panties, 1980's sailor suits, brown living room curtains ordered from a catalog, and tight shoes. For people under 40 there's not a lot to love here, and they don't have any secondary brands or businesses to fall back on anymore. Where's the appeal? Where's the growth?"

CAPS member NEVERFADE seconds that emotion, calling J.C. a "[d]ying brand. Will continue to lose market share as younger shoppers find it less desireable than competitors."

And adding overvaluation to insult, All-Star investor kurtdabear laments that "though better managed than many of its competitors, JCP will not be able to escape unharmed. With a PE north of 20, it's already seriously overpriced."

Now, I'm certain J.C. Penney would vigorously disagree with these sentiments. Indeed, when reporting earnings last month, the company trumpeted its "results exceeding sales and earnings expectations." Management further promises to grow sales in the "low-single digit range in 2011" and produce earnings per share of $2 or more this year -- a 22% improvement over 2010 profit.

J.C. Penney: Make it yours?
But here's the thing: Those profits aren't backed up by real, honest-to-goodness free cash flow. Despite vigorous cutting of capital expenditures, J.C. Penney endured a precipitous drop in operating cash flow in 2010, with the result that free cash flow for the year fell to just $93 million. That's less than a quarter of the profits J.C. Penney claimed under GAAP accounting standards.

So even if management is right about sales growing somewhat this year, I don't see much chance of this translating into free cash flow gains that might justify the share price. The more so when you consider that J.C. Penney has promised to ratchet up capital expenditures by roughly 30% this year, to $650 million. (In fact, if J.C. Penney only grows cash flow by the few percent that it's projecting sales to rise, it's entirely possible that J.C. Penney might burn cash this year.)

Time to chime in
The way I see it, rather than waste dollars on this Penney stock, bargain-shopping investors are better advised to travel upmarket a bit and invest in Nordstrom (NYSE: JWN) or Macy's (NYSE: M). Both Nordstrom and Macy's sell for P/E ratios considerably cheaper than Penney's. Even better, and in contrast to J.C. Penney, both these stocks generate more free cash flow than they report as GAAP net income. Faced with numbers like these, the obvious question arises: "Why pay more?"

Seriously -- that's not a rhetorical question. You know what I think about J.C. Penney, and now here's your chance to fire back. If you've got a different opinion of the stock, click here and tell us about it.