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.

An explosive reaction
If "Opposite Day" was an actual holiday, then consider specialty chemicals maker Albemarle on temporary vacation.

The maker of specialty polymers and catalysts used by the electronics, automotive, and refining industries reported first-quarter results in late April that fell well short of Wall Street's estimates. Net income for the quarter fell by 26% as sales declined 10%, with management pointing to continued weakness in the coming quarters because of weak electronics sales domestically and sluggish auto sales in Europe.

Despite these poor results, Albemarle's share price has been on fire, presumably under the suspicion that domestic economic data is improving and that, at 11 times forward earnings, Albemarle could still be an intriguing value. As for me, I'm putting my trust in short-sellers -- at least in the short-term.

That earnings report was ghastly! The company's catalyst segment -- its largest -- saw sales plummet by 20% while its polymer segment managed higher-volume sales but saw prices slump badly. This is not a recipe for success. The company did boost its dividend by 20% and initiated a massive share repurchase program that'll buy back 10% of all outstanding shares by year's end in an effort to support shareholders; however, it did nothing to address how to grow the business. Until we see prices improve and Europe's economy stabilizes, this is a company I'd suggest avoiding altogether.

Steady as she goes
Despite a steady return to profitability, the distrust of residential mortgage-backed security and commercial real estate debt holder Newcastle remains evident.

Newcastle recently declared a quarterly payout of $0.17 per share, which, while down from the $0.22 paid out in the previous quarter, would still equate to an annualized yield of 12%. Furthermore, the company completed its spinoff of former subsidiary New Residential Investment (RITM 0.45%) in early May. This new company does own nearly half of Newcastle's asset portfolio and should make it easier for investors to understand how Newcastle makes its money, and could help unlock value in Newcastle's share price, which is notably below book value.

However, I'd be quick to point out that while the underlying financials are improving dramatically, there's still a major risk that could cripple Newcastle. Newcastle relies on a stable economy in order to pay out huge dividends and remain healthfully profitable. Quite a bit of its portfolio is devoted to below-investment-grade mortgage securities and debt, which puts it at a significant disadvantage if the economy turns south. Unlike agency REITs, which can lever up with the understanding that their loans are backed by the U.S. government, part of Newcastle's asset portfolio has no fail-safe, meaning it takes MBS defaults on the chin. This means that if the Federal Reserve begins paring back its bond-buying program, Newcastle investors should be on high guard in case housing growth slows to a crawl or even retreats.

Playing catch-up
I can somewhat understand the reasoning behind a bet against telecom services giant AT&T, because in terms of next-generation wireless services, Verizon (VZ -0.53%) is running circles around its peers. Verizon is covering far more active 4G LTE-capable cities than AT&T, Sprint Nextel, and T-Mobile combined, which gives it an inherent advantage in acquiring new customers. In AT&T's latest subscriber figures, we saw these struggles become apparent as it did add 296,000 new net subscribers during the quarter, but actually lost 69,000 high-value phone subscribers.

However, who in their right mind would bet against the inelastic pricing dominance of AT&T or its incredibly steady cash flow? We've witnessed AT&T's commitment to catching Verizon with its plans announced last year to spend $14.4 billion on wireless infrastructure upgrades over the next three years. Although the trickle-down effect of these infrastructure upgrades tends to help network-equipment providers long before we see any follow-through in service providers, make no mistake about it: AT&T will see these benefits soon enough.

AT&T is also getting increasingly optimistic about its future. The company is forecasting net additions of 500,000 subscribers in the second quarter, which would be a nice improvement. With a 5% yield and a product that borders on necessity, this isn't a company I'd recommend betting against.

Foolish roundup
This week's theme is all about whether or not the business is healthy. Forget the dividends and the buybacks; can the business grow? For Albemarle, that question is still unanswered, while plenty of question marks could exist for Newcastle, too. In AT&T's case, its pricing power and wireless upgrades look poised to provide the growth needed to drive its share price even higher for years to come.

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.