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 number of shares sold short and see whether traders are blowing smoke or if their worry has some merit.

Company

Short Increase Feb. 15 to Feb. 28

Short Shares as a % of Float

Lowe's (NYSE: LOW  )

136.8%

3.6%

Office Depot (NYSE: ODP  )

57.8%

13.4%

3D Systems (NYSE: DDD  )

60.1%

29.2%

Source: The Wall Street Journal.

Outdueled by the Depot
With the housing sector beginning to show signs of life from both the commercial and consumer ends, investors have been predominantly indiscriminate with what housing-related companies they're bidding higher. Most investors aren't too surprised to see do-it-yourself home retailers Lowe's and Home Depot (NYSE: HD  ) heading higher, but I'd propose that they should be concerned about Lowe's rise.

I tinkered in my head whether or not I felt Lowe's deserved its run over the past year, given its sketchy results and I've come to the conclusion that it hasn't earned that right yet. Lowe's suffers from a number of factors that put it at an inherent disadvantage to Home Depot.

The biggest difference is that Lowe's is significantly more reliant on lower-margin appliance sales than Home Depot. Home Depot's product assortment has sold much better than Lowe's, which has made playing catch-up difficult. Secondly, Home Depot implemented a series of technological improvements in its stores long before Lowe's, which made its employees and point-of-sale systems considerably more efficient. Finally, Home Depot just has the brand-name advantage.

Lowe's fourth-quarter results, released in February, speak to an improving company with 1.4% same-store sales growth globally. But it also points to a company that's light-years behind Home Depot with just 0.6% total sales growth in 2012, a year that saw a dramatic need for rebuilding domestically from hurricanes Irene and Isaac. Lowe's online business could be its saving grace, but in the meantime, this is one I'm perfectly fine letting the short-sellers tear down.

The greater of two evils
Some have called the pending buyout of OfficeMax by Office Depot a merger that needed to happen -- I call it the merger that neither party really wants. This is the type of merger that challenges the theory of whether two wrongs can make a right.

All three office-supply chains -- Office Depot, OfficeMax, and Staples -- have struggled over the past four years as convenience and cheapness have won out, with previous customers buying their office products online. Staples has been the most proactive among the three with regard to how it plans to counteract this trend. It has been actively downsizing its stores and announced that it'd be carrying Apple accessories recently. Rumor even has it, according to MacRumors, that Staples may begin carrying the iPhone, iPad, and Mac as well, which would provide an incredible boost to its foot traffic.

Office Depot and OfficeMax are going to counter this trend from a pure cost-cutting perspective. They'll merge their companies, trim the fat, close quite a few stores, and pray that they don't send too many of their faithful customers to Staples with their store closures and inevitable integration issues. My projection is that it could take two years, or more, for this newly combined entity to find its footing and realize any demonstrable synergies. That's more than enough time for Staples to accrue an additional 2%-3% benefit to its U.S. sales, tack on additional market, and assert itself as the clear office-supply leader both in the bricks-and-mortar, and possibly online, space. My suggestion is to let the short-sellers pick this deal apart like vultures that they are.

One degree of separation
The story of 3-D printing specialists 3D Systems and Stratasys (NASDAQ: SSYS  ) are actually quite similar. Both have taken to growing aggressively through acquisitions, and both are relying on the inescapable truth that we as investors are awful predictors of precisely when a new technology becomes truly feasible.

The way I see it, there's only one degree of separation that matters between Stratasys and 3D Systems -- their bottom-line profits. In Stratasys' fourth-quarter report at the beginning of March, it delivered 23% sales growth and a forward looking adjusted profit projection of $1.80-$1.95. Much of this growth relates to its merger with Objet, a 3-D printing company that can offer significantly more diverse and rapid prototyping to the enterprise market.

3D Systems, on the other hand, fell short of the Street's fourth-quarter sales estimates by $2.3 million. Furthermore, its full-year EPS forecast of $1.00-$1.15 met estimates, but it seemed a bit disappointing given how quickly it had been growing. I think another key point worth noting here is that 3D Systems has made 31 acquisitions in three years and integration issues are bound to come up. Most investors have little clue how to value these companies yet, and I'd just as soon let the short-sellers have their way with 3D Systems until the bottom-line results become more in line with top-line expectations.

Foolish roundup
This week's theme is simple: Short-sellers, they're all yours! Lowe's hasn't shown any real ability to close its underperformance gap with Home Depot, Office Depot is going to struggle mightily to both Staples and online competition, and 3D Systems is going to cope with a frothy valuation and an ongoing amalgamation of acquisitions.

What's your take on these three stocks? Do short sellers have these stocks pegged, or are they blowing smoke? Share your thoughts in the comments section below.

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  • Report this Comment On March 19, 2013, at 10:23 AM, TangoXray7 wrote:

    A little late to the party there Sean. The time to worry was about three weeks ago.

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