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 sold short and see whether traders are blowing smoke or if their worry has some merit.

Company

Short Percentages Increase March 15 to March 30

Short Shares as a Percentage of Float

Yelp (NYSE: YELP  ) 174.5% NA
Alaska Air (NYSE: ALK  ) 52.8% 3.1%
Qihoo 360 Technology (NYSE: QIHU  ) 16.0% 64.8%

Source: The Wall Street Journal. NA = not available.

A bark worse than its bite
You sort of knew that high levels of short interest in Yelp were going to be inevitable when not one of the four underwriters who spearheaded Yelp's IPO placed a buy rating on the stock. The truly scary aspect of this social restaurant and business ratings site is that its forward P/E of 385 might not be the worst part!

Much like Angie's List (Nasdaq: ANGI  ) , which has been losing money for 16-plus years in its attempt to get members to pay for a service that they can essentially get for free elsewhere, the barrier to entry in social review sites is practically non-existent. Yelp is totally reliant on advertising to grow its business, and the last time I checked, advertising follows the ebb and flow of the economy. Because of its ability to trim costs, I can see Yelp actually becoming profitable (unlike Angie's List), but there's little reason in trying to justify its current valuation. Short away, folks!

It's a regional thing
In an era where bigger is better, the airline sector may want to adjust its mode of thinking. Alaska Air last week reported its second-highest net income for the first-quarter period in its history. What's more impressive, it did so while fuel costs rose by 64% to $319 million over the previous year. At this pace, fuel costs will be roughly $188 million higher this year than in 2011.

But this speaks to the pricing power and flexibility of regional carriers as opposed to national airlines. While national carrier Delta Air Lines (NYSE: DAL  ) and its peers are reducing capacity and cranking out some ridiculous fees in order to generate revenue, Alaska continues to expand its fleet and increase passenger revenue per available seat mile and load factor -- two important metrics for airlines -- without making expenses unrealistic for its passengers. Alaska really is just doing things better right now, and short-sellers would be wise to take note of that.

Will Qihoo 360 make a 180?
For those of you short-sellers who expected Qihoo 360 to make a 180 because of its 10-K, you just got told!

In a rare case of transparency, Qihoo was able to respond to allegations of potential financial fraud based on a Forbes report and get its auditor to sign off on its financial statements. With many short-sellers banking on Qihoo being another in a long list of Chinese scams, this was quite the awakening. It also proves that not all Chinese companies are fraudulent.

However, news of Qihoo's victory doesn't necessarily make it a great buy, either. At 143 times cash flow and 40 times sales, Qihoo leaves a lot to be desired in the value department. With the market looking toppy, a potentially pricey company like Qihoo stands to be one of the first companies hit if the overall market heads lower.

Foolish roundup
This week really comes down to the long-term viability of each company's business model. Yelp and Qihoo have serious questions to answer about their valuation and how they'll deal with increasing levels of competition, while Alaska must show it can continue to one-up the national airlines.

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 using the links below to add 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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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 24, 2012, at 1:29 AM, seasaw6499 wrote:

    No offense, but Qihu is clearly a fraud. Their response on Forbes definitely doesn't help them, imo. Neither does the auditor signing off on the financials, particularly when the auditors point out material weaknesses and deficiencies in the internal controls of the financial reporting.

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