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 31 to August 15

Short Shares as a % of Float

Weight Watchers (NYSE: WTW  )

64.6%

18.5%

Community Health Systems

(NYSE: CYH  )

60.9%

3.7%

Alcatel-Lucent (NYSE: ALU  )

43.6%

0.7%

Source: The Wall Street Journal.

Trimming the fat
If you thought the technology sector was notoriously cyclical, then you obviously haven't paid attention to the nutrition/gym sector, which tends to cycle from up to down and back again about two times each year. My gripe with nutrition-oriented companies is that brand loyalty is practically nonexistent. No one seems to care how they get weight-loss results as long as they come easily. Therefore, when expenses in their lives rise or a better deal comes along, those consumers tend to jump ship.

We saw this to a T in Weight Watchers' second-quarter results, which were released at the beginning of last month. For the quarter, Weight Watchers reported a 2.5% decline in global engagement, a dip in EPS to $1.15 from $1.36 in the previous year, and reduced its full-year EPS forecast -- although that was with good reason since it took a charge to refinance its debt to a lower interest rate.

We have seen time and again from nutrition-oriented businesses that when consumer spending weakens or the economy shows even the slightest hint of uncertainty -- be it from Syria, Obamacare, or rising mortgage rates -- consumers tighten their wallets. Weight Watchers' main course of action to improve shareholder value over the past decade has been in repurchasing shares. While that's helped its recent EPS figure a bit, it doesn't mask a recent lack of top-line growth. Until Weight Watchers can develop a way to improve customer retention, I suspect short sellers will retain the upper hand.

Risking too much?
With the Patient Protection and Affordable Care Act, known affably as Obamacare, set to go into full effect -- at least from an individual mandate perspective -- on January 1, numerous hospital and acute-care facility stocks have been trading higher. The reason is simple: If people are required by law to have insurance or face a penalty, it should help reduce hospitals' doubtful provisions account relating to patients treated without insurance. But might shareholders be getting a bit ahead of themselves?

It's quite possible, with Community Health Systems agreeing in late July to buy Health Management Associates (NYSE: HMA  ) for $3.9 billion, that it bit off more than it can chew. With the deal, Community Health will inherit HMA's $3.5 billion in outstanding debt to go with its $9.1 billion in existing debt. Furthermore, Community Health is financing its purchase with, you guessed it, more debt!

We also can't note the positives for the hospital sector if we don't point out that the individual mandate penalties in the first year are very small. Furthermore, the IRS issued guidelines recently, which noted that it will not go after individuals who owe the penalty but do not pay. Ultimately, the passing of the PPACA, at least over the next two years, may have little material impact on doubtful accounts at hospitals if people simply choose to take the penalty. With that in mind, at least over the near term, short sellers may indeed be in control of Community Health Systems.

You must learn to walk before you can fly
On Friday, I declared it open season for network equipment makers. The reason behind my bullish declaration has to do with wireless service providers opening up their wallets in order to upgrade their 4G LTE networks. As this money cascades down the line, it winds up in the hands of fiber optic and fiber optic product manufacturers and, eventually, networking companies like Alcatel-Lucent. But has Alcatel-Lucent already spread its wings prior to this clearance for takeoff? I believe so.

I figured Alcatel-Lucent was a unique value in the low $1 range. Above $3, though, there are still plenty of questions left to be answered. For one, when is Alcatel-Lucent going to return to profitability? Aside from a rare annual profit in 2011, it hasn't regularly turned in quarterly profits since 2005, which is also the last year it produced positive free cash flow. Another pending question is: When will Alcatel-Lucent stop writing down assets? In its second-quarter results, the company took a 552 million euro impairment charge on assets and another 194 million euro charge on restructuring charges. It seems like every time you turn around these days, it's another writedown.

Instead of pumping Alcatel-Lucent any higher, may I suggest trading it out for Cisco Systems (NASDAQ: CSCO  ) ? Cisco's products are synonymous with cloud computing and big data center storage, and they're bound to come in handy as wireless service providers push toward universal 4G LTE acceptance. With steady cash flow and profitability, it appears to be a considerably more attractive choice than Alcatel-Lucent, which I would leave to short sellers here.

Foolish roundup
It doesn't happen all too often, but this week's theme is leave it to the short sellers. All three companies appear to be biting off more than they can chew with their current valuations -- Weight Watchers with its poor brand loyalty, Community Health with its high debt levels, and Alcatel-Lucent with its ongoing losses and writedowns.

The three companies we examined this week may not have panned out as expected, but that doesn't mean your search for revolutionary companies has to end here. Motley Fool co-founder David Gardner, founder of the No. 1 growth stock newsletter in the world, has developed a unique strategy for uncovering truly wealth-changing stock picks. And he wants to share it, along with a few of his favorite growth stock superstars, WITH YOU! It's a special 100% FREE report called "6 Picks for Ultimate Growth." So stop settling for index-hugging gains... and click HERE for instant access to a whole new game plan of stock picks to help power your portfolio.


Read/Post Comments (7) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 09, 2013, at 8:05 PM, youngblood58 wrote:

    Disagree on the Cisco over ALU call. Think ALU is a considerable turaround story and Cisco is just sputtering along in the low 20s.

  • Report this Comment On September 09, 2013, at 11:39 PM, Hrsemn wrote:

    Hey Sean make sure you keep track of WTW. Remember it is a major brand name. Lets see where it is 6-24 months from now.

  • Report this Comment On September 10, 2013, at 7:44 PM, Holechaser69 wrote:

    I'm not worried at all about short piling in. Its a beautiful thing when they are forced to cover...lol ALU will continue to rise.

  • Report this Comment On September 10, 2013, at 7:45 PM, goldman2too wrote:

    only a true fool would short alu now. sounds like the few still holding out hope they don't have to lose their shorts literally. this stock is going past 5 and will be at 10 soon after.

  • Report this Comment On September 11, 2013, at 12:04 AM, wholesalecd wrote:

    How much did Cisco pay you for your genius expertise here? They better ask for that back because you did a horrible job a making a case against ALU. And shorts are good especially when they have to cover and the stock goes up even more because of them. LOL.....Nice try

  • Report this Comment On September 11, 2013, at 3:45 AM, DanTheMan1984 wrote:

    ALU has 2.3 billion shares or so outstanding and even with the increase not even 1% of the float is shorted, so why is that a worry Sean?

  • Report this Comment On September 11, 2013, at 8:14 AM, ghstflame wrote:

    I love the ALU bit; not even 1% of the shares are short!

    $10 by 2015; buy all you can under $5, High teens/share in 2016-2017.

Add your comment.

DocumentId: 2629395, ~/Articles/ArticleHandler.aspx, 4/16/2014 9:51:34 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement