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 condemning 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 29 to July 13

Short Shares as a % of Float

RPM International (NYSE: RPM  )

82.0%

2.3%

Health Net (NYSE: HNT  )

79.4%

3.5%

UBS (NYSE: UBS  )

44.4%

0.3%

Source: The Wall Street Journal.

Vroom-vroom!
Nearly 2,000 companies paid a dividend last year, and I only feature one a week in my "great dividends to buy" series; yet RPM International found its way into that series in early May. RPM, which makes paints, coatings, and adhesives for the commercial and consumer housing industry, is benefiting from a resurgence in home prices and new home orders and the continued push from consumers to remodel their homes with lending still out of reach for certain homeowners.

In the company's most recently ended quarter, it reported a 12% rise in sales as the North American housing market continued its slow recovery and industrial coating sales zoomed higher. D.R. Horton (NYSE: DHI  ) , the United States' largest homebuilder, reported a 25% rise in new home orders in its latest quarter as the entire sector is seeing stabilizing prices and rising new orders -- all great news for RPM.

Admittedly, RPM was a little lackluster on its growth forecasts going forward, but with 38 straight annual dividend increases under its belt and a two-pronged approach to success from a commercial and consumer side, I wouldn't dare bet against this company.

Anybody have Tums?
What happens in California, affects your pocketbook. Health insurers are struggling with higher commercial and Medicaid costs across the board and few have had much success in boosting prices. In a true case of prescient investing, short-sellers appear to have front-run the milewide earnings miss by Health Net last week perfectly!

For the quarter, Health Net, which operates primarily out of California, noted higher expenses from commercial businesses and Medicaid, as well as a $61 million one-time expense due to claims left over from the first quarter. In all, Health Net reported a $0.20 profit when Wall Street was projecting $0.66. What's more, Health Net drastically lowered its full-year outlook for the second time in just three months. Prior to May, the company had forecast EPS in a range of $3.30-$3.40. The updated forecast calls for just $1.00-$1.10 in EPS. Yikes...

With WellCare Health Plans falling under the guillotine as well, I can't help but side with the shorts on most health insurers until they work out their kinks and figure out a way to control expenses and pass along rising costs to consumers.

Pay the piper
Most banks already have money set aside to cover bad loans; I'm beginning to think maybe they should have a separate fund known as the "Whoops loss-reserve" to cover all of their moments of ethical short-comings.

UBS, along with Barclays (NYSE: BCS  ) , is currently under extensive investigation for fixing the LIBOR, the interbank lending rate between 16 U.K. banks that helps determine mortgage, credit, auto, and countless other loan rates. Barclays and UBS have fessed up to their roles in the scandal and only now are we beginning to see the ramifications of their unethical actions. Barclays, found liable of fixing LIBOR for its own financial gain, had a $456 million judgment levied against it by securities regulators, and could be facing billions in prospective lawsuits.

As of last week, UBS' CEO, Sergio Ermotti, mentioned that UBS isn't a central figure in the LIBOR-fixing investigation, but the bank, nonetheless, could be facing a stiff fine and lawsuits just like Barclays. Until the scope of this investigation becomes more clear, I can't help but agree with short-sellers' rising levels of pessimism.

Foolish roundup
This week it's all about the "macro." A company like RPM, which can benefit from both the consumer and commercial side, is set up to succeed in nearly any environment. As for Health Net and UBS, higher costs and legal woes are threatening to bite hard into their bottom lines and I'd think twice before buying either one.

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.

And 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 Costco. Motley Fool newsletter services have recommended buying shares of Costco. 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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