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 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 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 their worry has some merit.

Source: The Wall Street Journal.

Apple rumors abound
Nam Tai Electronics has had an incredible run over the previous two months, and it has rumors surrounding its new secretive partner to thank.

Nam Tai's second-quarter report was nothing short of phenomenal. In it, the electronic component and OEM supply company noted the addition of a new customer for its high-resolution liquid crystal display modules. Specifically, Nam Tai began producing LCMs for tablets in June and began producing them in mass scale as of last month. As a result, Nam Tai's report highlighted a 62.8% rise in revenue and a sharp 182.8% jump in gross profit.

Beyond the numbers, the real reason Nam Tai is off to the races has to do with a potential affiliation with all-things-digital kingpin Apple (AAPL -0.69%). With Apple potentially rolling out an iPad mini in short order and continuously producing updates to its iPad, there's a possibility Nam Tai won the contract with Apple to be one of their primary suppliers, if not their only one . Right now, these are just rumors and short-sellers do have a reason to be skeptical after such a large price jump, but Nam Tai has traded at such a historically low valuation relative to book for years that I don't see betting against the company now as a prudent course of action.

Didn't we learn our lesson?
It's no secret that in spite of housing data suggesting we may have found a bottom, I'm not sold on this recent rally across the sector. New homes are being sold at an annual rate of 373,000, which is a two-year high, but it's also well, well below the historical average and the 1.4 million annualized sale rate from 2005.

That brings me to M/I Homes, which announced last month that it was going to be raising $50 million to bolster its cash pile in order to make land purchases and build more houses. Although we've seen generally positive results from homebuilders like Lennar (LEN 1.27%) whose 23.2% homebuilding margin leads the sector, M/I Homes is in no way near the same shape as Lennar.  

Despite 12 straight quarters of positive EBITDA, M/I has only reported breakeven EPS results through the first half of fiscal 2012. It's also achieved at least some of its profitability through expense reduction, which, while good, doesn't signal to me that homebuilding margins are really strong -- at least not yet. The overall metrics for M/I are heading in the right direction, but probably not at a pace to merit its current valuation. Short-sellers could be on to something here.

The rain in Spain...
As goes the global economy, so goes Morgan Stanley's wealth management division -- or at least investors seem to think so.

Morgan Stanley reported second-quarter results what seems like an eternity ago back in late July, and it marked the first quarter since the financial crisis in which Morgan Stanley produced more in net revenue than its largest rival, Goldman Sachs. Morgan Stanley's $9.3 billion in net revenue was boosted by growth in equity trading and fixed-income markets, as well as fees earned from bringing IPOs to market.

Still, there are reasons for short-sellers here to feel vindicated in light of Morgan Stanley's great quarter. For one thing, much of that boost from bringing IPOs to market has passed in the third quarter with Facebook essentially squashing most IPO demand. Second, volatility has been down in the third quarter, which bodes well for its fixed-income division, but should weigh on its equity trading operations. Finally, the cloud that is Europe continues to hang over Morgan Stanley's asset management division and provides enough impetus for short-sellers to pile into the stock. I consider myself in the center of that pendulum and think Morgan Stanley's upcoming report will go a long way toward helping me decide whether I'm optimistic or pessimistic on the stock.

Foolish roundup
This week's theme is all about "Are we there yet?" For Nam Tai, an attractive valuation has been there for years, while M/I Homes and Morgan Stanley may still have a lot to prove before short-sellers give up their holdings.

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.

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