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 for 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 July 15 to July 31

Short Shares as a % of Float

SAP (NYSE: SAP  )

54.4%

0.8%

Men's Wearhouse (NYSE: MW  )

80.9%

8.5%

Lender Processing Services (NYSE: LPS  )

70.7%

1%

Source: The Wall Street Journal.

A cloudy outlook for software
There's little debating that the transition from internal-based computer systems to cloud-based data centers is going to revolutionize small and large businesses and drastically improve business workflow. The problem is that going from point A to point B is taking a lot longer than expected.

Application software that manages and/or analyzes data in the cloud space has struggled in recent quarters as government austerity measures in both the U.S. and throughout much of Europe are constraining, or flat out delaying, new orders. Oracle (NYSE: ORCL  ) , often looked at as one of the more dominant players in this space, has now delivered two straight quarters of cloud-licensing disappointment. In its fourth-quarter results announced in June, Oracle saw cloud-based revenue trickle up by just 1% and commented that the majority of weakness actually came from previously fast-growing emerging markets.

That news bodes poorly for SAP and is probably a good indication of why short-sellers had been regularly adding to their positions prior to its second-quarter earnings results released last month. As expected, SAP showed modest cloud-subscription growth, but delivered disappointing results from its Asia Pacific region, where cloud-based revenue dipped 7%. Furthermore, while essentially sticking to its full-year growth forecast, it subtly guided investors to expect its double-digit growth to come in at the lower end of forecasts without saying those exact words.

As with Oracle, I can see SAP's earnings weakness over the near term continuing; however, I see significant opportunity five or 10 years down the road for this company to be trading higher than where it is now.

Investors don't like the way this looks
What's the return policy if we don't like the way this looks? That's what investors of Men's Wearhouse could be asking themselves after a very rocky 2013 that saw the company's CEO and iconic head for decades, George Zimmer, fired.

In June, shares of Men's Wearhouse were whipsawed after news of Zimmer's firing hit the newswires. Zimmer claimed he was pushed out of his role as a director while the Men's Wearhouse's board claimed that Zimmer was unwilling to hand over the reins of control even though he was no longer CEO. Zimmer's ouster certainly raises doubts about Men's Wearhouse's advertising campaign moving forward, given that Zimmer and his catchphrase had become synonymous with the brand. Will the company be able to differentiate itself? Short-sellers aren't so sure.

Another complicating factor here is that rival Jos. A. Bank (NASDAQ: JOSB  ) updated its second-quarter outlook late last week and its guidance didn't quite match Wall Street's expectations. The company actually noted that total sales for the quarter declined 11% year over year, and that EPS is expected to come in at $0.49 to $0.53 as compared to the current consensus of $0.68. This could be particularly worrisome news for Men's Wearhouse, since they're often competing for a very similar customer, and given that Men's Wearhouse has ongoing transition concerns with Zimmer's departure. For now, I'd say short-sellers just may have the upper hand.

Growing concerns
For a vast majority of the financial sector, rising interest rates are viewed as an excellent sign and a big reason that net interest margins (a measure of profitability between what a bank borrows at and what it lends at) are expected to rise. For mortgage-lending service software provider Lender Processing Services, it's the worst possible news imaginable.

In Lender Processing Services' latest quarterly results, we were able to see just how beneficial low lending rates have been in encouraging mortgage lenders to purchase its analytics software. The company reported an adjusted profit of $0.22 compared to a year-ago loss of $0.45, and was helped out in a big way by considerably lower legal expenses.

However, mortgage rates have been on the rise since May with mortgage banking activity having dropped by 53% since its peak. That bodes very poorly for Lender Processing Services, which relies on low lending rates to drive business. With rates having been kept so low for so many years, consumers have essentially been spoiled and are very unlikely to jump at rates now, which are still very low by historical standards. The company may seem relatively inexpensive at 13 times forward earnings, but that figure could easily rise if mortgage applications keep sinking.

Foolish roundup
This week I'm unanimously siding with the short-sellers, at least over the short term. International cloud-sales are notoriously weak, dooming SAP; Men's Wearhouse's transition concerns as well as weakness in main rival Jos. A. Bank bode poorly over the near term; and Lender Processing Services' direct ties to lending rates signal what could be a slowdown in its software and analytics business.

Although the American markets have hit numerous all-time highs this year, investors and pundits alike are skeptical about future growth... but they shouldn't be. Many global regions are still stuck in neutral, and their resurgence could result in windfall profits for select companies. A recent Motley Fool report, "3 Strong Buys for a Global Economic Recovery," outlines three companies that could take off when the global economy gains steam. Click here to read the full report!


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