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. That leaves investors with ample opportunities to make money whether they choose to go buy stocks or sell them short.

A large influx of short-sellers shouldn't be an immediate 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 Since June 30

Short Shares as a Percentage of Float

Target (NYSE: TGT  ) 25.4% 1.9%
Goodyear Tire & Rubber (NYSE: GT  ) 40.6% 7.0%
KB Home (NYSE: KBH  ) 17.8% 34.3%

Source: WSJ.com.

Target
This was sort of a head-scratcher: Who in their right mind would bet against Target? I thought about it more, and the premise does make sense if you expect input costs to rise faster than the company can raise its prices. However, that whole theory drowns when panic-selling events like what we've witnessed the past two weeks occur and many raw material prices fall off a cliff.

Target does face stiff pricing competition from Wal-Mart (NYSE: WMT  ) and traditional grocers such as Kroger (NYSE: KR  ) . But the company's rewards program (most notably its Redcard) and its credit card business have been growing quickly enough to outpace rising costs and to maintain a loyal consumer base. Target's quarterly distribution has also doubled in just four years, with the yield currently sitting at 1.9%. Bet against a rapidly rising dividend and a loyal customer base? No thanks!

Goodyear Tire & Rubber
Just when you thought Goodyear was ready to drive all over consensus estimates, rising costs put a flat in the company's growth outlook. Traders seem to have correctly anticipated the company's earnings shortfall next quarter. In Goodyear's words, it expects raw materials costs to rise in excess of 30% for the second half of this year. So are short-sellers vindicated in their bearishness? Maybe...

While I thought Cooper Tire & Rubber (NYSE: CTB  ) made an equally compelling buy in the tire sector, it appears clear that Goodyear is the company with all of the momentum. Goodyear has clobbered consensus estimates by 200%, 325%, and 141% over the past three quarters, proving that analysts have little bearing as to where this company is headed. One bullish thesis here is that with more used cars on the road now than at any point in history, Goodyear's total volume should be booming. I'm not quite ready to give Goodyear my blessing yet, but I wouldn't say short-sellers have this completely right either.

KB Home
Pop quiz! What do you call a 34% short ratio on KB Home? The right answer.

It seems with nearly every earnings report that KB Home is ready to turn the corner, but alas, it never comes true. One area I continue to remain decidedly bearish on is housing, specifically the middle-to-high income homes that KB specializes in. With a debt-to-equity ratio approaching 400%, and a sea of losses expected this year, I find it difficult to justify why the company is still trading above its book value when peers like MDC Holdings (NYSE: MDC  ) , which is much better capitalized, trade below book value. I'm pretty confident the shorts have this one right.

Foolish roundup
Whether it's rising costs or falling demand, it pays to pay attention to the movement of short-sellers in and out of a stock. While short-sellers may not always have the story right, it's best to be able to see both sides of the story that can, in the end, help protect your portfolio from unnecessary losses.

Do short-sellers have these three companies pegged properly? Share your thoughts in the comments section below and consider adding Target, Goodyear Tire & Rubber, and KB Home to your watchlist.

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. The Motley Fool owns shares of Wal-Mart. Motley Fool newsletter services have recommended buying shares of MDC Holdings and Wal-Mart, as well as creating a diagonal call position on Wal-Mart. 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 never needs to be sold short.


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