Shorts Are Piling Into These Stocks. Should You Be Worried?

The best thing about the stock market is that you can make money in either direction. Historically, stock indexes have tended to trend up over the long term. But when you look at individual stocks, you'll find plenty of stocks that lose money over the long haul. According to hedge fund institution Blackstar Funds, even with dividends included, between 1983 and 2006, 64% (nearly two-thirds) of stocks underperformed the Russell 3000, a broad-scope market index.

A large influx of short-sellers shouldn't be a damning factor to any company, but it could be a red flag from traders that something may not be as cut-and-dried as it appears. Let's take a look at three companies that have seen a rapid increase in the amount of shares currently sold short and see if traders are blowing smoke or if their worry could have some merit.

Company

Short Percentage Increase, Aug. 31 to Sept. 15

Short Shares as a Percentage of Float

Polaris Industries (NYSE: PII  )

113.5%

8.8%

Carnival (NYSE: CCL  )

37.6%

3.9%

Direxion Daily Financial Bull 3X (NYSE: FAS  )

151.4%

NA

Source: The Wall Street Journal. NA = not available. 

Off the beaten path
Since highlighting Polaris nearly one year ago as a company that just might drive over its competition, the company has definitely lived up to those lofty expectations.

In its latest quarterly filing, Polaris reported a 90% increase in net income on a 41% jump in revenue. All aspects of Polaris' business are showing strong growth, with international sales increasing 35% and North American sales rising 43%. Perhaps the strongest aspect of its latest report was the 300 basis-point jump in gross margin due to lower product and warranty costs, higher selling prices, and favorable currency translations. So why investors now chose to increase their short positions by 113.5% is beyond me. Polaris has put rival Arctic Cat (Nasdaq: ACAT  ) in its rearview mirror, and if short-sellers aren't careful, they may get run over as well.

From cruise to tank?
Everyone needs a vacation now and then, and those looking for a getaway might just choose Carnival. At prices that pale in comparison to the cost of some international flights, Carnival cruises offer travelers a nice getaway.

Based on results from its most recent quarter, Carnival has thus far been able to stave off a weakening U.S. economy. Revenue and earnings both surpassed Wall Street estimates, and the company's booking guidance for the first half of 2012, while cautious, seemed to indicate low single-digit growth and higher booking prices. The one concern that investors would be smart to keep their eyes on is fuel prices. Rising fuel costs caused the company to guide earnings to the lower-end of previous forecasts and could be the main reason shorts have taken a liking to Carnival. With 4.5 million more shares held short relative to two weeks prior, consider this company on watch.

House rules
I admit, when I go to the casino, I'm immediately drawn to the roulette table and its 35:1 odds. Naturally the owners of the casino also light up with joy knowing that I'm throwing money at a game which gives the casino the greatest edge. Well, folks, leveraged ETFs are the exact same thing -- minus the casino.

Based on recently reported data, it should come as no surprise to anyone that short-sellers added 8.8 million shares to the Direxion 3X Financial Bull ETF. Because of daily rebalancing and time decay, ETF investments that provide leverage make terrible long-term investment vehicles. This holds true for the ProShares Ultra S&P 500 (NYSE: SSO  ) , the ProShares Ultra Silver (NYSE: AGQ  ) , and especially the VelocityShares Daily 2X VIX (NYSE: TVIX  ) -- leveraged investments are trader traps! Let the shorts do what they will with them.

Foolish roundup
No major epiphany this week. Simply avoiding flash-in-the-pan leveraged ETFs and not betting against companies which continue to crush earnings estimates will go a long way to protect your portfolio from unnecessary losses.

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy that's triple leveraged toward transparency.


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