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 if their worry has some merit.

Company

Short Percentage Increase Feb. 29 to March 15

Short Shares as a Percentage of Float

Marathon Petroleum (NYSE: MPC  ) 117.7% 3%
Pepco Holdings (NYSE: POM  ) 159.6% 10.1%
AutoZone (NYSE: AZO  ) 75.4% 3.5%

Source: The Wall Street Journal.

Refiner-eeeek!
Life isn't always easy being a refiner. High gasoline prices only translate into bigger profits for oil refiners if they can both get consumer demand to rise and pass along price increases effectively to those consumers. Lately, neither has happened. Consumers have been resistant to the near-record gasoline prices and, while they've driven an additional 1.3% more miles than last year, they've done so by using 2.5% less gasoline. Biofuels and more fuel-efficient vehicles are making life tough on refiners.

Marathon, however, is one of the few that I wouldn't lump in the underperformers category. Following a split from parent Marathon Oil (NYSE: MRO  ) last year that divided its upstream and downstream operation -- and with ConocoPhillips (NYSE: COP  ) also opting to split up its operations up in order to unlock shareholder value -- the long-term prospects for refiners and their shareholders remain bright.

Most successful refiners are close to their oil sources, which is something that should bode well for Marathon and help keep its costs down. In addition, the relative cheapness of West Texas Intermediate relative to Brent Crude should keep the company busy as that widening gap will boost demand. With a yield north of 2%, this is not a refiner I'd bet against.

The debt cycle
I'm not a big fan of debt of any form. I'm even less of a fan of debt when it becomes a self-perpetuating cycle as it has with Pepco Holdings, a transmitter and distributor of electricity and natural gas.

The company in early March offered nearly 15.6 million shares on the open market in order to generate cash to pay off short-term debt obligations. This comes on the heels of 14 million share offering in December 2008 where it once again offered shares in order to raise cash to pay off short-term debt. As of the end of 2011, the company's debt/equity of 51% seemed dangerously high, as did its $5 billion in debt relative to only $109 million in cash.

Pepco didn't offer much solace in the form of its earnings results, either. Total revenue dropped 18.7% in the latest quarter with its power delivery segment leading the charge lower with a sales decline of 39.2%. Given that Pepco has missed Wall Street's EPS targets in two straight quarters, I'm with the short-sellers on this one.

Get out of the zone
Let's be clear, my track record on picking AutoZone to underperform stinks. But I nonetheless stand firm that the company is a ticking time bomb.

In December, I noted four particulars about AutoZone that make it a particularly strong sell candidate in my books: a growing debt load, slowing same-store sales growth, increased share repurchases clouding the fact that there was little true earnings growth, and no insider purchases. Since that article, its debt load has risen by $110 million more, insiders have continued to sell shares at a regular pace, and it boosted its share repurchase program by $750 million. The growth here just doesn't seem sustainable to me, and I'm in perfect agreement with short-sellers on AutoZone.

Foolish roundup
This week it really came down to debt. Marathon may have $3.3 billion in debt, but it also has $3.1 billion in cash. AutoZone and Pepco don't have nearly that much cash on hand and rely on debt increases to run their business. That seems like a gambler's proposition if you ask me!

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. 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. 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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