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

Jarden (NYSE: JAH  )

142.4%

8.2%

CommonWealth REIT (NYSE: EQC  )

53.1%

3.8%

US Airways (NYSE: LCC  )

47.7%

19.7%

Source: The Wall Street Journal.

Is Jarden sizzling or souring?
There's very little denying the fact that a rebound in the housing sector and continued success in sales of outdoor equipment is playing perfectly into the hands of Jarden, a maker of outdoor and branded consumable products. Jarden owns a portfolio of easily recognizable brand names, such as Crock-Pot, Coleman, Mr. Coffee, and Oster, and utilized 3.5% organic net sale growth to burst to a new 52-week high. You might say short-sellers are getting quite the squeeze at the moment, but I'm slowly being won over to their cause.

While I like what Jarden's done with controlling costs and making long-term investments in its core brands, 3.5% organic growth isn't enough to cut it at a company valued at 21 times trailing earnings. Jarden had a lot fall its way in the fourth quarter, with a big earnings boost thanks to the absence of a writedown in fourth-quarter 2011, and the timely rebound of the housing market. It won't have those same benefits next year, which could stop this rally dead in its tracks.

I will give Jarden's management team credit for accelerating its share repurchase program and attempting to boost shareholder value, but upside without additional acquisitions seems rather limited after its amazing run.

The roof, the roof, the roof is on fire
Is Nero fiddling while Rome burns? That's what activist hedge fund investors Corvex Management and Related Fund Management would like you to believe of CommonWealth REIT's executive committee.

In late February, CommonWealth, an office real estate investment trust, dove on news that it was planning a 27-million-share cash-raising offering. The very next day, Corvex and Related Fund Management released an open letter demanding CommonWealth retract its share offering, and offered its take as to how CommonWealth could be worth as much as $50 per share if the company's management team were replaced. The investment firms, which owned 9.8% of the company's shares at the time of the letter, noted that management's interests weren't tied to investors' interests, and that they would consider purchasing the outstanding shares of CommonWealth at a nice premium. 

Unfortunately for Corvex and Related, things aren't working in their favor. Last week, a judge in Maryland denied their request to halt arbitration against CommonWealth that would make it more difficult for investors to get a seat on CommonWealth's board. Although it appears that value could still be unlocked, CommonWealth's management team seems hell-bent on making sure Corvex and Related Fund remain on the sidelines and, thus, short-sellers have a very strong case in betting against the company.

The worst company… ever?
In February I declared the potential combination of US Airways and American Airlines parent AMR (UNKNOWN: AAMRQ.DL  ) the worst company ever. A week later the companies announced their intention to merge, and I still stand by this assessment.

My biggest beef with large national carriers is that they aren't nimble enough to compete with the price-undercutting ability or route flexibility of smaller airlines. For example, Spirit Airlines and Alaska Air both have the ability to tweak routes as needed if fuel prices or load factors make it unprofitable to run a route. US Air and AMR won't have those same luxuries if fuel prices soar or if consumer travel declines.

From a financial perspective, the combined entity is going to be rife with debt, which is going to put it at a distinct disadvantage to smaller carriers like Allegiant Travel, which is net cash positive. It could also make it more difficult for national carriers like US Air to make new purchases or lease planes if the opportunity arises.

Finally, history is a terrible precursor of what could be on the way. Not a single national carrier made it through the past 10 years without declaring bankruptcy, and the combination of United Air and Continental to create United Continental Holdings, which was supposed to result in cost synergies, actually resulted in higher expenses last year. You haven't seen merger-related hiccups until you've seen two airlines the size of US Air and AMR trying to merge. Short-sellers, US Air is all yours! 

Foolish roundup
No mincing words this week: All three companies have had sizable runs higher, but not a single one looks attractive as a long-term investment due to a mixture of weak organic growth, poor leadership, and a trend of historical underperformance.

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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