Following the trail of short sellers is a journey that can lead to big financial surprises, not all of which are pleasant. Case in point: Motley Fool Stock Advisor recommendation Shuffle Master (Nasdaq: SHFL ) .
In early August, Foolish Contributor Extraordinaire Rick Aristotle Munarriz took a look at 3 Stocks You'll Love to Hate, which included Shuffle Master -- the king of automatic card shuffling (and much, much more). At the time, the short interest ratio (the number of shares sold short -- bets the stock would decline -- divided by the average daily volume) was a high 19 days.
Rick questioned why anyone would want to wager against a company that has been a handicapper's delight -- coming in slightly ahead of its profit projections as it has for seven straight quarters. Good question.
Ah, but that record has now been broken! Shuffle Master's third-quarter results came in at the high end of guidance at $0.23 a diluted share. That's an outstanding 29% increase over the comparable quarter a year ago. Revenue rose a strong 18%.
Investors liked what they saw and sent the stock up 19.2% in early-morning trading (although the stock had settled back to a 14.5% gain by midday). The rise was probably fueled in part by short sellers buying back shares to cover their positions.
Shuffle Master is trading at a rich 33.8 times the company's projected $0.82 a share earnings for fiscal year 2005 (which ends in October). But that multiple is within reason, given that analysts expect the company to compound earnings by 26.0% annually for the next five years.
The company has made a number of moves to keep its future looking bright. It teamed withInternational Game Technology (NYSE: IGT ) and Progressive Gaming (Nasdaq: PGIC ) , who are developing a comprehensive table management solution for the worldwide gaming industry. It also purchased the radio frequency identification (RFID) patents that are the basis for the Gaming Partners (Nasdaq: GPIC ) products that embed microchips into everything from dice to playing cards to chips -- still a niche business at present. In addition, Shuffle Master recently augmented its side-bet portfolio.
The potentially bad news here is debt. Net debt, debt minus cash, stands at $113.7 million. Debt-to-equity (D/E) stands at 7.3 times (although, currently, there is plenty of cash to cover interest payments). In fairness, this doesn't represent an immediate threat, but it does have the potential to become problematic if growth stalls and debt growth outpaces the aforementioned.
Investors looking to buy into top-tier gaming companies might have a tough time finding a free lunch, particularly in the case of Shuffle Master, when so many short sellers are looking for an opportune moment.
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Fool contributor W.D. Crotty does not own shares in any of the companies mentioned. Click
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