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 their worry has some merit.

Company

Short Percentage Increase April 13 to April 30

Short Shares as a Percentage of Float

Watson Pharmaceuticals (NYSE: WPI  ) 64.9% 2.1%
Coach (NYSE: COH  ) 41.0% 1.7%
Sun Life Financial (NYSE: SLF  ) 48.2% 0.9%

Source: The Wall Street Journal.

Not your generic short-sale
I continue to be mystified by investors who would dare bet against generic drug producers, but here we are again, with Watson attracting a flurry of short-selling in light of another great earnings report.

Buoying that report was strong growth in Watson's generic-drug segment, which saw revenue spike 86% from the year earlier. During the quarter, the company launched 60 new drugs and filed 28 new drug applications. Remember, the key with generic-drug makers is that it's all about quantity. Generic-drug manufacturers don't have to spend nearly as much on research and development as branded-drug makers do, so they can instead undercut the price of the branded drug and reap the benefits of large unit sales once a patent expires.

In particular, Watson is one of the generic-drug producers that pounced on the opportunity to market the now off-patent best-selling drug in the world: Pfizer's (NYSE: PFE  ) cholesterol drug, Lipitor. The competition among generic producers for generic Lipitor is fierce, with even Pfizer doing everything within its power to hang on to its once-powerful drug, including offering a generic version of its own. However, Watson's continuous stream of new products makes it a company you'd be crazy to bet against.

No pumpkin here
This Coach isn't turning into a pumpkin at midnight, so I feel short-sellers have the wrong impression.

Coach, maker of everything from high-end purses to jewelry, has faced increasing concerns that a slowdown in Europe and Asia could weaken its bottom line. In addition, I've even cautioned that slow wage growth doesn't appear to support a prolonged period of consumer discretionary spending. But, don't tell that to Coach, which is currently one of the strongest brand-name products money can buy.

In its latest quarter, Coach reported a 17% rise in sales, which helped catapult net income higher by 21%. Better yet, Coach also boosted its dividend by 33%. Although Coach hasn't paid a dividend for very long, it's been no stranger to announcing large dividend hikes. All aspects of its business are growing robustly, from its owned-and-operated stores to its online sales segment.

Investors wanted to assume that Fossil's (Nasdaq: FOSL  ) earnings miss would mean bad news for luxury retailers like Coach, but the reality is that Coach is perhaps the strongest brand name out there at the moment.

Sunny days are here again
As Sun Life's commercial slogan goes, "One day you'll know our name." Well, why not today?

Sun Life Financial, Canada's third-largest insurer, had been plagued the past two quarters by volatile market conditions that wreaked havoc on what is otherwise a very conservative investment portfolio. After reporting two large quarterly losses in which the company shored up its reserves against losses, Sun Life is once again back in the black. For optimists, it looks like sunny days are here once again.

The best news here is that not only did Sun Life absolutely crush Wall Street's expectations, but that it did so while its rivals Manulife Financial and Industrial Alliance struggled. Sun Life announced a turnaround plan months ago that entailed focusing on Asia and unwinding some of its unprofitable U.S. operations. We're finally seeing those moves begin to pay off in the company's bottom-line results.

With the company confident about its future and, thus far, confident that its dividend yield of 6.5% is sustainable, I feel shorts are once again playing with fire.

Foolish roundup
One, two, three times the fool (small "f") this week! Not every stock with rising short interest poses a problem, and all three companies mentioned here look very well positioned for long-term success.

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 Fossil. Motley Fool newsletter services have recommended buying shares of Pfizer, Coach, and Fossil, as well as shorting shares of Fossil in a separate newsletter. 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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