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.

Source: The Wall Street Journal.

Cleared for takeoff?
What a difference a little over five months has made in the bottom line of aircraft parts supplier Spirit AeroSystems.

If you recall, I selected Spirit as a company near its 52-week low that was worth buying in November, shortly after its big drop, on the suspicion that its strong ties to Boeing (BA -0.24%) and its new 787 would help drive results moving forward. Traders, on the other hand, homed in on Spirit's whopping $590 million writedown related to multiple contracts. Spirit's most recent quarterly report would show that baby steps are being made in Spirit's turnaround.

For the quarter, revenue improved 17% over the year-ago period despite profit remaining flat. Better yet, Spirit stuck by its previously issued full-year adjusted EPS forecast of $2.20 to $2.40, placing the company at a mere seven times this year's earnings projections. Investors seem to forget that Boeing has invested far too much money and effort to let the 787 stay grounded, and, with Spirit being a spinoff from Boeing in 2005, it'll undoubtedly maintain a tight relationship with its former parent company.

It's worth keeping a watchful eye on government military spending cutbacks, as they could negatively affect Boeing's military orders and trickle down to Spirit, but I feel that short-sellers are still playing with fire by betting against Spirit AeroSystems now that it's secured a new CEO and backed its full-year forecast.

Can this stock power any higher?
I haven't been a fan of most California electric utilities since the energy deregulation of 2001 nearly put many of them out of business. Edison International gained my ire in January 2012 with a massive debt load, little top-line growth, and falling profits. More than one year later, and I'm beginning to see the first winds of change for Edison, but we're still years off from these changes making a genuine difference.

Edison has managed to lower its net debt total down to $9.45 billion in the past 14 months, and is making a big push in rebuilding its infrastructure to include energy created by natural gas and solar -- two clean energy sources.

However, Edison is also struggling, as is evidenced by the $402 million in costs it recorded through Dec. 31 for repairs and replacement power costs to its San Onofre nuclear power plant. Furthermore, the same concerns I had about little revenue growth and no EPS growth still exist if you compare its 2012 results to this year's estimates. Higher expenses to rebuild its infrastructure coupled with potentially lower electricity prices in certain parts of California could derail Edison's margins for a while to come. Tack on the fact that Edison's yield of 2.7% underwhelms relative to the electric utility sector, and I feel it still has "avoid" written all over it.

Is the sun rising on this REIT?
On Friday, I highlighted mortgage-REIT American Capital Agency (AGNC 0.99%) as a great dividend you could buy right now. The reasoning behind my conviction in American Capital's hefty 15.3% yield was the contention that the Federal Reserve may begin winding down its bonds purchases (which include MBS's) as early as this summer if the American economy keeps picking up steam. Without the government nabbing MBS's, better and more profitable options will be available for mREITs like American Capital. 

Whereas American Capital deals solely with agency loans -- those backed by the full faith of the government -- the optimism could extend outward to non-agency MBS purchasers like Two Harbors Investment as well. Non-agency mREITs offer the prospect of higher net interest margins than agency-only mREITs, but they also come with significantly more risk, as their non-agency losses aren't backed by the government. This means that highly levered non-agency mREITs run the risk of not being able to get sell their MBS's if the housing market turns sour.

For Two Harbors, it's really a bit of a toss-up. The stock has already had an amazing run higher, so short-sellers could be on to something. Then again, Two Harbors' nearly 11% yield isn't likely to fall if the housing market doesn't deteriorate.

Foolish roundup
This week's theme is all about affirmation. Spirit's backing of its full-year guidance makes me feel confident that it's heading higher, while Edison's waffling on San Onofre and its near-term expenses gives me plenty of reasons to worry about its growth prospects. For Two Harbors Investment, it all depends on whether or not the Fed sticks to its word.

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.