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 May 31 to June 14

Short Shares as a % of Float

Orange (NYSE: ORAN  )

59.9%

N/A

T-Mobile (NYSE: TMUS  )

63.4%

7.2%

Target (NYSE: TGT  )

23.5%

2.8%

Source: The Wall Street Journal. N/A = not available.

Caution tape around Europe
Guilt by association is a dangerous thing for communications service provider Orange, which, until July 1, had been previously known as France Telecom.

The big concern for Orange is ongoing austerity measures in Europe, which are targeted at reducing large government budget deficits in troubled countries. With not one but many countries instituting austerity measures, growth in the EU is forecast to be constrained for perhaps years to come. That's a particularly concerning scenario for Orange, which derives a good chunk of its revenue from its operations in France and other Western European nations. It's also the reason France Telecom took a hit last week on renewed austerity protests in Portugal.

However, there's a good reason I own Orange in my personal portfolio: its cash flow and emerging-market potential.

I purchased Orange late last year because I saw a company that was particularly inexpensive on a cash flow basis. Orange is currently valued at what I forecast to be six times this year's cash flow, but more like three-to-four times its average over the past decade. That's particularly cheap, considering that it has double-digit growth potential in Africa, and that it hasn't lost too many customers to low-cost wireless service provider Free Mobile in France.

Even with a reduced dividend, Orange is set to pay out a dividend that is approaching nearly 12% of its current market value this year. I'm perfectly happy collecting that dividend in the meantime and banking on an emerging market-induced turnaround in Orange by as early as 2014.

Lagging behind its peers
Sticking with the telecom service sector, T-Mobile, which recently completed its purchase of MetroPCS Communications to boost its subscribership and image, appears to be attracting the ire of short-sellers once again.

The promise of the MetroPCS buyout is that it brings 9 million new members under its wing, but the deal won't be without its fair share of challenges. MetroPCS's network is brutally outdated with regard to the proliferation of smartphones in the United States. To that end, T-Mobile plans to, within the next two years, completely shut down MetroPCS's network and push current MetroPCS users onto its T-Mobile platform. There are countless questions and concerns about this move, which I'd refer to as a necessary evil, but the ones at the forefront are the customer attrition and transition costs, which could be particularly high with this course of action.

There's also the competitive advantage that T-Mobile still doesn't possess. Even with Sprint Nextel (NYSE: S  ) selling a majority stake to SoftBank and T-Mobile buying MetroPCS, it leaves both the No. 3 and No. 4 wireless providers eating the dust of AT&T and Verizon. The good news for Sprint is that it has the capital needed to build out its 4G LTE network, and T-Mobile now has an audience that's 9 million larger to pitch its small but growing 4G LTE network to. Ultimately, though, Verizon's current 4G LTE network is offered in more cities than every other U.S. wireless service provider combined. Regardless of the near-term buildout for Sprint or T-Mobile, their efforts are akin to trying soak up the water in a swimming pool with a paper towel.

I'd certainly exercise skepticism with regard to any rally in T-Mobile's stock, and I think short-sellers may have viable reasons to be concerned moving forward.

The next great retail disappointment?
Is Target beginning to lose its swagger? One might suspect so, after its weak first-quarter results forced it to lower its full-year profit outlook. For the quarter, same-store sales declined 0.6% and marked the first time since 2009 that a year-over-year sales comparisons had dropped. Target blamed a lot of factors for its shortfall, but most notably it pointed to colder weather, which kept seasonally strong items such as clothing on the sales rack.

As for me, I see something completely different at work here, which makes me concerned about the immediate future for Target, but it also gives me hope that it'll be able to pull itself out of this latest funk.

The bigger issue here is the same issue that sacked rival Wal-Mart (NYSE: WMT  ) in the first quarter -- tax refund delays. Blame the cold weather all you want, but Wal-Mart and Target both sell seasonal discretionary high-margin items that move out the door shortly after tax refunds are divvied out. With the IRS furloughing employees because of the sequester, many had their refund checks delayed weeks or even months, which is simply going to push sales of these higher-margin items a quarter or more down the road for both retailers.

However, both Target and Wal-Mart have tapped into the trend of customer convenience, expanding their stores to accommodate grocery items. Although grocery items often come with very low margins, they serve to keep customers coming back to the store more often, it keeps them in the store longer, and it makes them more loyal to the brand. Target really has the advantage here, as its REDcard encourages loyalty by providing in-store discounts for customers.

Over the long run, I suspect Target will once again find the bull's-eye, but I could see one or two more quarters of hiccups before it gets back on track.

Foolish roundup
This week was all about differentiating short-term worries from long-term problems. Orange and Target both have near-term concerns, but both have plans in place that should deliver solid cash flow for years to come. T-Mobile, on the other hand, seems to be waging a losing war.

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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