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 their worry has some merit.

Company

Short Percentage Increase Jan. 13 to Jan. 31

Short Shares as a Percentage of Float

Arch Coal (NYSE: ACI  ) 39.1% 8.1%
BankUnited (NYSE: BKU  ) 97.9% 8%
Masco (NYSE: MAS  ) 28.7% 4%

Source: The Wall Street Journal

Taking its lumps
The coal sector has taken its fair share of lumps recently. With natural gas prices hovering near decade lows, we’ve begun to see a tangible shift away from coal and toward natural gas for electrical generation. A January rail-traffic update from Genesee & Wyoming (NYSE: GWR  ) last week confirmed this, with coal shipments for the railroad operator falling by 40%. Still, betting against Arch Coal might not be the smartest move.

Coal is responsible for nearly half of all electricity generation in the United States. It’s not going to just disappear overnight. Arch Coal itself is possibly the cheapest name in the coal sector, trading near its lowest valuations in a decade at just six times forward earnings and 3.6 times cash flow. Arch also pays one of the best dividends in the sector at 3.1% and is currently trading for only 84% of its book value. Short this stock? I’m seriously considering buying it for myself once the Fool’s disclosure policy allows me to.

Not for sale
The end of January was quite a busy time for BankUnited. The company reported solid fourth-quarter results but also took the “for sale” sign out of its front yard.

On the earnings front, the Florida-based bank reported a profit of $0.42, which was significantly better than the $0.30 profit it earned in the year-ago period. More importantly, its tier-one capital ratio rose to 10.8%, and the percentage of non-performing loans dropped to a negligible 0.7%. As mentioned, the Blackstone Group, which is part of the private-equity group that took over BankUnited in 2009 and had been exploring a possible sale, decided to take the bank off the market after being unable to field any acceptable bids. With that being said, at 1.5 times book value, BankUnited is looking awfully pricey -- especially now that it’s not looking to be sold. Short-sellers have a decent reason to be skeptical of BankUnited’s valuation here, with many other banks trading much closer to book value.

I’ll huff and I’ll puff…
The big bad wolf sure has done a number on Masco, a supplier of cabinetry and plumbing systems for new homes. Since the housing bubble popped in 2007, Masco has been unable to mount any momentum, and the company’s fourth-quarter report last week validated that the industry’s big bad wolf is still roaming the streets.

Masco’s fourth-quarter loss of $0.09 came in $0.06 worse than Wall Street had predicted, despite revenue that rose by 1% to $1.74 billion. Even with major homebuilders like Lennar (NYSE: LEN  ) reporting a 20% increase in new home orders, Masco has 1.34 million foreclosed homes on the market which are going to take years to sell through. Long story short (oh, look, I made a funny), short-sellers appear to be on the correct side of this trade.

Foolish roundup
Valuation is always important, but this week it really takes the cake. With BankUnited no longer for sale and Masco facing tough business prospects, short-sellers just might be onto something. As for Arch, they’re barking up the wrong tree.

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 these stocks to your free and personalized watchlist to keep up on the latest news with each company.

Also, if you'd like to avoid the potential pitfalls that high short-interest can bring, I suggest you download a copy of our latest special report: "The Motley Fool's Top Stock for 2012." In it, our chief investment officer gives you the skinny on a company he has dubbed the "Costco of Latin America." Best of all, this report is completely free, but only for a limited time. Don't miss out!

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. He wonders if strawberry shortcake is a sellers-only dessert. 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. The Motley Fool owns shares of ArcelorMittal. 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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