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.

Company

Short % Increase June 15 to June 29

Short Shares as a % of Float

Coach (NYSE: COH  ) 50.2% 4.1%
Dollar General (NYSE: DG  ) 65.8% 3.2%
Market Vectors Semiconductor ETF (NYSE: SMH  ) 69.8% N/A

Source: The Wall Street Journal. N/A = not applicable; its share count constantly changes.

Coach
Among luxury retailers, it definitely hasn't been breakfast at Tiffany's the past few quarters, with the high-end jewelry retailer issuing multiple earnings warnings. So the next logical step for investors is to dog-pile on luxury retailer Coach, which has significant exposure to Asia. With China's second-quarter GDP growth slowing to "just" 7.6%, a three-year low, worries persist that Coach's sales may suffer. China and Japan currently have a total of 269 Coach retail outlets.

The thing to remember here with Coach is that it's extremely efficient with maximizing its square foot usage and putting the right products in front of its customers. Despite June's U.S. retail sales signaling that the middle-class consumers are clamping down on their wallets more, Coach still has a broad appeal among both middle- and upper-income consumers.

This strong appeal has translated into nothing short of phenomenal growth. Sales jumped 17% in the third quarter, with China providing the biggest boost -- a 60% sales jump. Coach also boosted its dividend by an additional 33% and continues to repurchase its shares. A strong brand name coupled with shareholder-friendly management isn't a combination I'd bet against.

Dollar General
And here I thought I was the only one crazy enough to suggest looking at the dollar store as a possible short-sale candidate. Apparently, there are almost 3.4 million more shares sold short this period than the prior period, which speaks to the investor skepticism surrounding the sector.

Dollar stores have thrived on cost-conscious consumers who don't have the disposable income they once did, and through aggressive marketing and fixed, easy-to-understand, pricing strategies, they're able to keep these customers coming back to their stores. One similarity dollar stores do share with general retailers is they also have higher-margin (and often higher-price) discretionary items they need to move to boost their margins. If these items stop selling, then Dollar General, which I feel is priced for perfection, could fall the hardest in the sector.

Also, keep in mind that Dollar General pays no dividend and has nearly $2.9 billion in total debt. Operating cash flow is strong enough to more than cover its debts at the moment, but let's not forget that the company has $1.2 billion in debt payments due in the next three years. I'll give Dollar General credit for paying down $1.5 billion in debt since 2008 and pushing $880 million worth of maturities out from 2014 to mid-2017, but that's still a lot of debt to deal with. It's all yours, short-sellers!

Market Vectors Semiconductor ETF
Tell me if you've heard this story before: China's growth is slowing and the world is worried! Yeah, it's the same story, but it has multiple implications across many sectors -- including the semiconductor sector.

Thus far, the chip sector has been a mixed bag, with Applied Materials (Nasdaq: AMAT  ) warning that an order slowdown would cause it to miss earnings. On the other hand, Intel (Nasdaq: INTC  ) continues to see strong chip demand, and contracted fabless semiconductor manufacturers Taiwan Semiconductor and United Microelectronics are having trouble keeping up with demand thanks to the explosion in smartphones and tablets.

Guessing which way this ETF will go is definitely a toss-up. On one hand, weakened chip prices and slowing growth in Asia may cause order delays or cancellations from certain tech companies. On the other hand, cheaper prices are more conducive to lower raw material costs which are both business- and consumer-friendly. However, given that Intel and Taiwan Semiconductor combined to make up one-third of this ETF and their demand shows little signs of weakness, I'd say short-sellers should be on guard to abandon their positions.

Foolish roundup
This week was all about macroeconomic trends. As much as we don't want to hear about China day in and day out, its spending and manufacturing growth have been the motor that's kept the global economy afloat. All three companies here will be greatly affected by whether China's economy has a soft or hard landing.

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!

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 Tiffany, Intel, and Costco. Motley Fool newsletter services have recommended buying shares of Coach, Intel, and Costco, as well as shorting shares of Tiffany in a separate newsletter service. 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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