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% of stocks -- nearly two-thirds -- 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 look at three companies that have seen a rapid increase in the amount of shares currently sold short and see whether traders are blowing smoke or whether their worry could have some merit.

Company

Short Percentage Increase, Nov. 30 to Dec. 15

Short Shares as a Percentage of Float

CSX (NYSE: CSX  ) 25.4% 1.1%
iShares Gold Trust (NYSE: IAU  ) 745.7% NM
Polypore International (NYSE: PPO  ) 24.9% 18.4%

Source: The Wall Street Journal. NM = not meaningful; ETFs don't have a fixed float of shares.More powerful than a locomotive? Puh-lease!Superman may have been able to stop a speeding locomotive, but it's going to take a whole lot more than a jump in short-sellers to slow down the momentum at CSX.

Railroad companies have been on a tear over the past few years, and it all comes back to one key point: Higher fuel costs are making it less profitable for trucking companies to ship goods. Investors don't often think of railroad locomotives as "fuel-efficient," but on a per-ton basis, trains are significantly more fuel-efficient modes of transportation than trucks. It's no surprise then that CSX recorded record third-quarter profits in October and logged an operating ratio of only 70.4%. You can stand in the way of this behemoth if you like, but you'll probably wind up getting crushed.

The two-faced trader
It's amazing how quickly your biggest supporters can turn on you when the tide changes direction. For the past few years, gold has been the mainstay of most traders' portfolios, with notables John Paulson and Dennis Gartman championing the yellow metal higher. In recent months, however, these champions have sold some or all of their gold holdings, which has created a mass exodus out of the once safe-haven investment. The question now becomes, "Is this warranted?"

I'd have to say yes and no. The dollar was long overdue for a bounce off its lows, and with gold acting as a dollar hedge, it isn't surprising to see it dropping. Then again, there's enough negative data from a global perspective that it could choke an elephant, which makes gold as a hedge still a smart maneuver. I remain of the camp that gold miners are a better buy than physical gold itself, especially those that pay a dividend. Newmont Mining (NYSE: NEM  ) has even tied its dividend to the average spot price of gold. Nevertheless, I don't see anything wrong with owning some of the lustrous metal here. Shorts, consider yourselves warned!

Warning signs
Every once in a while a company looks OK on the surface only to reveal subtle clues that raise possible red flags when you dig deeper. Polypore is one such company.

For starters, Polypore insiders have been exiting the stock in droves. Since May, insiders have sold 7.3 million shares in 18 separate transactions, including shares obtained through option exercises. Although I don't have the ability to be inside management's brain, I'm inclined to think that insiders feel the stock is fully valued here and their selling is a warning sign to shareholders. Another aspect worth noting is that after three straight quarters of double-digit earnings beats, Polypore just squeaked by Wall Street's estimates in the third quarter. With short-sellers having now established a short position north of 18% in the stock, I'm more than willing to sit on the sidelines and let the shorts have their way.

Foolish roundup
This week, it's all about paying attention to the subtleties. If the warning signs are there, heed them; otherwise, consider the seas smooth sailing.

What's your take on these three stocks? Do the short-sellers have these stocks pegged, or are they blowing smoke? Share your thoughts in the comments section below, and consider adding CSX, iShares Gold Trust, and Polypore International to your free and personalized watchlist to keep up on the latest news with each company.

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, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong. Motley Fool newsletter services have recommended buying shares of Polypore International. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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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