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 whether their worry has some merit.

Company

Short Increase Sept. 28 to Oct. 15

Short Shares as a % of Float

WellPoint (NYSE: WLP  )

67.9%

3.7%

Greenway Medical Technologies

(NYSE: GWAY  )

99.6%

7.2%

Emulex (NYSE: ELX  )

50.4%

4.5%

Source: The Wall Street Journal

A presidential bump?
It may not seem like it on paper, but health-plan solutions provider WellPoint is in good shape regardless of who takes the helm as President of the United States come January.

Under President Obama, the Affordable Care Act will be implemented in full by 2014 and WellPoint will welcome millions of newly covered individuals thanks to the expanded Medicaid coverage written into the bill. WellPoint is ready to capture as many of these newly insured individuals as it can with its recent agreement to purchase Medicaid-based health-plan provider Amerigroup (NYSE: AGP  ) . There had been some concern that increased regulation would stymie price increases, but that's been far from the case. Aetna's earnings report last week, for instance, crushed Wall Street's estimates and pointed to rising premiums and stable medical costs. 

Under a Romney administration, WellPoint would almost assuredly see a repeal of the Affordable Care Act and would face far less discerning regulation with regard to premium boosts. In addition, it would continue to reserve the right to turn away those patients with preexisting conditions. From a purely financial perspective, WellPoint would be in good shape under this scenario too.

No matter how you look at it, WellPoint at just eight times forward earnings is a value, and I wouldn't dare bet against the company.

A cloudy forecast with a chance of profits
Just because an idea makes sense on paper doesn't mean investors are necessarily going along for the ride.

Greenway Medical Technologies is a relatively young company that's aggressively working its way into the growing field of cloud-based health-care management solutions. Greenway's PrimeSUITE applications allow companies to store electronic health records, as well as coordinate ambulatory care. Back in August, Greenway landed a giant customer in Walgreen (NYSE: WAG  ) , which chose it to handle its electronic health records.

But one thing stands between Greenway and a higher share price: its lofty valuation. As a smaller company, Greenway's growth rate has been phenomenal. Its fourth-quarter report, released in late August, highlighted a 24% increase in revenue and a 145-basis-point increase in gross margin. However, even with Greenway's robust forecast, it's still valued at a frothy 36 times forward earnings. This is a rare case where I'd personally be willing to overlook its pricey valuation because its recent Walgreen deal and rapid growth rate should translate into long-term success, but I could very easily see how short-sellers could get the upper hand here in the short term if Greenway's growth slows even the slightest bit.

If you build it, they will come
For storage and networking connectivity products providers like Emulex, the theory has long been that if they build these products, eventually service providers are going to need them. Unfortunately, for Emulex and its peers, the waiting game is getting awfully old.

One thing Emulex does have going for it is its pristine balance sheet: $186 million in cash and no debt. It's a cyclical company that has been known to dip into the red during recessions, but is likewise very profitable when times are good. Emulex is also trading very close to book value after reporting first-quarter results that weren't nearly as dire as Wall Street expected. Revenue grew by just 1%, but its all-important network connectivity products, which make up the bulk of its sales, jumped by 10%.

As a long-term play, Emulex makes sense because service providers will eventually need to invest in their infrastructure to keep up with demand. It could be a few years before this actually occurs, but there's little downside that I see left in Emulex's valuation.

Foolish roundup
Just when you think I'm The Motley Fool's curmudgeon, I turn the tables and point out three stocks being piled on by the shorts that should actually head higher. The long-term story for all three companies looks intact and I think short-sellers are barking up the wrong tree in each case.

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.

The upcoming presidential elections are bound to have a big effect on multiple sectors. Click here to get your copy of our latest special report, and see, for free, which four stocks our analysts feel could skyrocket when the elections are over.

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 WellPoint. Motley Fool newsletter services have recommended buying shares of WellPoint. 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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