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 Percentage Increase April 13 to April 30

Short Shares as a Percentage of Float

Arcos Dorados (NYSE: ARCO  ) 58.9% 6.4%
Sanofi (NYSE: SNY  ) 265% 0.5%
Sprint Nextel (NYSE: S  ) 131.7% 4.7%

Source: The Wall Street Journal.

Golden ouches
No, this isn't like a Coming to America flashback comparing McDonald's (NYSE: MCD  ) to McDowell's. However, this is comparing what is essentially an apple to an apple, and somehow investors are getting lost in the translation.

Arcos Dorados, the largest McDonald's franchisee in Latin America, can't seem to catch a break as currency weakness and operating inefficiencies continue to drag earnings below what Wall Street had expected. But should short-sellers be piling on like lettuce on a Big Mac? I hardly think so.

Arcos Dorados has grown its revenue for four straight years and has the undeniable power of the McDonald's brand behind its efforts. Understandably, visiting a McDonald's in the U.S. versus in Latin America is a completely different experience and the restaurants target a different customer, but the company is taking the appropriate steps to improve operating efficiencies and boost the bottom line. In its latest quarter, comparable-store sales increased 11.6%, which is a figure that none of the fast-food restaurants in the U.S. can even come close to. Currency issues aside (which it can't control anyway), Arcos Dorados remains a golden buy at these levels, and shorts could get grilled if they aren't careful.

Patent high dive
Next up on the patent exclusivity high dive is Sanofi. It appears short-sellers were prescient to be betting against its stock, because its recent earnings report was nothing to write home about.

Specifically, Sanofi noted that net income could fall as much as 15% this year as both Plavix and Avapro lose patent exclusivity in the United States. These drugs accounted for approximately 58 million euros of Sanofi's first-quarter revenue, although actual sales of these drugs were much higher as Sanofi merely sells the active ingredient in these two drugs to Bristol-Myers Squibb.

Sanofi's pipeline does have promise as it's currently collaborating with Regeneron Pharmaceuticals (Nasdaq: REGN  ) on an experimental drug, known as REGN727, that was shown to have lowered patients' bad cholesterol levels by 72% when used in combination with Lipitor in a company-funded study. But a company-funded study is a long way away from replacing a huge chunk of potentially lost revenue. Consider Sanofi a company worthy of caution tape at the moment.

One telecom's trash is another's treasure
Sprint Nextel CEO Dan Hesse spent quite a bit of time trying to orchestrate a merger between his company and MetroPCS Communications behind the scenes, only to have his board of directors shoot down the idea. Now it seems Deutsche Telecom's T-Mobile might be interested in snapping up MetroPCS.

Chalk this up as another case of how Sprint Nextel can't win for trying. Sprint simply can't compete with the two larger mobile networks in the U.S., AT&T and Verizon. Sprint hasn't turned an annual profit in five years, and the introduction of Apple's iPhone into its lineup of phone choices has only further drained its margins. Tack on a balance sheet that's absolutely riddled with debt, and it's not in the least surprising that short-sellers panned Sprint's shares over the past few weeks. Show me a profit, and I'll show short-sellers the exit. Until then, it's business as usual.

Foolish roundup
Outside of Arcos Dorados, as I think many investors don't truly understand how much currency fluctuations are affecting its bottom line, short-sellers seem to be on the right path. Sanofi's pipeline isn't the healthiest and Sprint is an investing minefield.

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.

The Motley Fool owns shares of Arcos Dorados and Apple. Motley Fool newsletter services have recommended buying shares of Arcos Dorados, McDonald's and Apple, as well as creating a bull call spread in Apple. 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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