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 whether their worry has some merit.

Source: The Wall Street Journal.

Safety in numbers
I may come across vehemently negative against the U.S. tobacco industry at times. But it's only because of the mounting regulations from the U.S. government and Food and Drug Administration, as well as the ongoing anti-smoking campaign by the Centers for Disease Control and Prevention, that make me so negative.

Potentially negative ad labels on packaging combined with an ongoing effort to educate the American public about the dangers of smoking are making it difficult for U.S.-based tobacco companies to grow. That's one reason Altria (NYSE: MO) announced significant layoffs last year as cigarette volumes continue to decline modestly in the U.S.

Internationally, however, Philip Morris International appears to offer the type of growth income-seeking investors can wrap their hands around. The company reported a 13% rise in sales in the first-quarter with Asia growing by double digits. The only weak region was Europe, which saw spending and currency weakness eat into Philip Morris' bottom line in the region. The company's plan to expand into regions like China and India that have a growing class of younger adult smokers and where it has only a minimal presence now should yield solid results over the next few years and beyond. Philip Morris' diversity among the 180-plus countries it operates in gives it a sort of safety in numbers you just won't get with domestic tobacco producers. Short Philip Morris? I think not!

Chi-NO!
Say it isn't so, China! The world's largest importer of copper, steel, gold, and a plethora of other materials has investors scared half to death that demand for these metals will dry up as China's growth slows to 7.5%. It's hard to believe, but after decades of high single-digit and even double-digit growth, 7.5% is considered "inadequate."

That could be particularly damaging for Freeport-McMoRan, which counts China as its largest customer for copper. It's one thing for construction and electronics growth to slow, but it's entirely different if stockpiles of copper build up within China and copper prices dive on the sudden oversupply. It's therefore imperative that Freeport remain prudent with its production capabilities since China does have the ability to affect copper prices.

In Freeport's latest quarter, the company shipped roughly 100,000 fewer pounds of copper and 190,000 fewer ounces of gold than in its previous year which confirms these suspicions. The next quarter is going to be very telling as the stock appears incredibly cheap at less than seven times forward earnings, but with a continued construction slowdown still fresh in investors' minds, the shorts understandably have a reason to remain skeptical.

Taken to the woodshed
You'd think with a small rebound in home construction and with more consumers choosing to remodel their homes, do-it-yourself home improvement stores Home Depot (NYSE: HD) and Lowe's would be sitting pretty.

Although both have performed well over the past year, it's Home Depot that continues to bully around Lowe's every chance it gets. Home Depot has successfully utilized its workforce and integrated newer technologies in its stores, allowing it to aggressively gain market share on Lowe's even though they sell almost identical products.

Lowe's main problem is that it's struggled with its heavy reliance on brand-name appliances. These brand-name products do get customers in the door, but they bear such low margins and take up so much valuable space that they've consistently been a drag on Lowe's bottom line. Until Lowe's can reverse its market share-losing trend, I'd say short-sellers have every reason to remain pessimistic.

Foolish roundup
This is the second week in a row we've had some very high-profile companies drawing the ire of short-sellers. For some, like Lowe's which is losing market share, and Freeport-McMoRan, whose largest product could see a decline in demand, the increase seems reasonable. For Philip Morris, I have to wonder what investors are smoking.

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 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!