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

Dean Foods (NYSE: DF  )

68.6%

4.1%

Arcos Dorados  (NYSE: ARCO  )

38.8%

14.4%

Arrow Electronics  (NYSE: ARW  )

38.7%

2%

Source: The Wall Street Journal

Spoiled milk
Dairy producer Dean Foods is showing signs of life for the first time in five years, but short-sellers don't seem particularly enthused about the move higher.

Dean has been dangling the carrot of spinning off various aspects of its operations in front of investors for months, but actually went forward with a $391 million spinoff of its WhiteWave-Alpro (NYSE: WWAV  ) unit last week. The proceeds from the spinoff will help Dean pay down some of its $3.6 billion in net debt and should allow it to focus more closely on the remaining aspects of its business.

However, short-sellers may still be correct in piling on Dean Foods for a number of other reasons. To begin with, food inflation costs have been wreaking havoc on all food producers, and Dean Foods is no exception. Also, Dean has been unable to grow many of its operations organically and has turned to acquisitions for growth over the years. Perhaps with Gregg Engles stepping aside to run WhiteWave-Alpro, Dean can get back on track, but I'll be convinced when I see tangible organic results.

Bronze arches
Arcos Dorados, the largest franchisee of McDonald's (NYSE: MCD  ) restaurants in Latin America, still can't seem to catch a break. You'd think that with the success of McDonald's restaurants domestically, Arcos Dorados would have immeasurable success in Latin America, but currency translations aren't cooperating.

On Friday, Arcos Dorados reported its third-quarter results, which showed a 2.2% decline in total revenue that was in part due to a large decline in Brazilian demand and its currency. But excluding negative currency translations, Arcos Dorados' comparable-store sales rose 6.5% and revenue rose 11.6% on an organic basis as 103 additional stores were opened over the previous year. In short, without currency issues, Arcos Dorados appears to be doing just fine. I can't say that these issues are going to disappear anytime soon, but its easily recognizable brand logo and diverse menu make it a solid long-term hold that I wouldn't dare bet against.

Shot through the heart, are shorts too late?
OK, forgive me for (mis)quoting Bon Jovi lyrics, but short-sellers have taken direct aim at electronics wholesaler Arrow Electronics despite it trading at just eight times next year's earnings. But is this pessimism warranted?

Last week Arrow reported that its net income dropped 19% as a 65% jump in restructuring charges and an 8% drop in electronic component sales hurt results. In addition, Arrow's fourth-quarter EPS guidance of $1.03 to $1.13 fell shy of Wall Street's expectation of $1.23, and worldwide PC sales are set to drop for the first time since 2001. Yet hope still exists for Arrow.

Lighter laptops and the beginning of a new tech cycle should spur demand in the PC sector in 2013. Also, Arrow has historically only failed to produce positive cash flow during recessions. Therefore, unless the U.S. economy dips back into a recession, short-sellers might be barking up the wrong tree with the company still very profitable.

Foolish roundup
This week's theme is all about "What have you done for me lately?" Both Arrow and Arcos Dorados have a long history of profitability as well as a good chance of a turnaround in 2013. As for Dean Foods, it'll need to show better organic growth before I'll give it a clean bill of health.

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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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 Dean Foods, Arcos Dorados, and McDonald's. Motley Fool newsletter services have recommended buying shares of, and creating a bull call spread position in, McDonald's. 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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