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 Aug. 15 to Aug. 30

Short Shares as a % of Float

GlaxoSmithKline (NYSE: GSK  )

69.8%

0.2%

Skechers (NYSE: SKX  )

57%

6.8%

Nordstrom (NYSE: JWN  )

45.5%

3.8%

Source: The Wall Street Journal.

Beware of cliff
It's pretty easy to understand why short-sellers have begun to pile onto pharmaceutical juggernaut GlaxoSmithKline: the patent cliff. Glaxo lost patent protection of its blockbuster asthma treatment Advair years ago, but the lack of guidelines of what testing would need to be done to get a generic version of the drug approved has kept its relevance front-and-center. Short-sellers are simply making a bet that Glaxo won't be able to replace revenue from the eventual approval of generic Advair faster than it can bring new drugs to market. The overall results recently are very mixed.

On one hand, short-sellers have every reason to be skeptical of Glaxo with a series of mounting drug failures. In August the company announced that its co-developed drug with ChemoCentryx, vercirnon, for the treatment of Crohn's disease, failed in late-stage trials. Just four weeks later, it was even more devastating news, with Glaxo and partner Prosensa (NASDAQ: RNA  ) announcing that Duchenne muscular dystrophy drug drisapersen had failed to meet its primary and secondary endpoints in a late-stage study.

Then again, Glaxo's COPD partnership with Theravance (NASDAQ: THRX  ) looks as if it's going to pay huge dividends going forward. The companies already had Breo Ellipta approved earlier this year for the treatment of COPD and the FDA panel recently gave a positive recommendation for approval for Anoro Ellipta. With two additional compounds still in the works, I'd say Glaxo's pipeline could remain healthy even with these recent failures since these COPD compounds could handily replace Advair's sales. I'd suggest short-sellers count their blessings if GlaxoSmithKline's share price falls.

Check your "tone"
Like GlaxoSmithKline, footwear company Skechers has plenty of positives and negatives pulling it in each direction. Skechers has been reeling for more than a year now from the PR fallout related to claims it made to consumers about its toning line of shoes. In addition, it's also struggled in Europe, where austerity measures across the region are hindering consumer spending from the top down -- although that isn't saying much, because what footwear company hasn't?

On the bright side, Skechers is looking at its first robust annual profit and revenue increase since 2010, which would establish a step in the right direction. Growth in other overseas markets outside of Europe has been strong, and as my Foolish colleague Alex Planes noted last month, e-commerce sales growth has exploded higher.

The real question is whether the damage done from its PR gaffe is in the rearview mirror and if Skechers can push even higher with Europe still a non-factor? I believe, given the strength of footwear since the recession, that it can. Skechers certainly doesn't meet the criteria of a top-performing stock, but its $198 million in net cash and double-digit sales growth would speak to a good chance for ongoing share-price appreciation.

Could this be a problem?
At first I found it a bit odd for Nordstrom to even be on this list given the niche customer it caters to. On paper at least the thought would be that higher-income consumers are going to be more resistant to the ebb and flow of the economy which would cause fewer deviations in Nordstrom's sales, ultimately helping its bottom line and keeping the short-sellers at bay. However, that all changed during the second-quarter when Nordstrom reduced its full-year EPS range by a median value of $0.075 per share and slashed its same-store sales forecast to a range of 2%-3% from the previous 3%-5% it had been forecasting.

The lesson here is simple: the consumer is really worried about adjusting to higher taxes this year, as well as the uncertainties surrounding the implementation of the Patient Protection and Affordable Care Act. Simply put, many consumers are dealing with higher expenses than last year and it's beginning to affect their purchasing habits.

Now, like the previous two companies we have some bright spots as well. Nordstrom's direct-to-consumer sales rose by an impressive 37% and total return on invested capital was 170 basis points higher year-over-year. 

Going short on Nordstrom really comes down to one factor: your time frame. Over the near term I could certainly see some additional downside as consumers of all income ranges in the U.S. tighten their wallets and investors adjust to Nordstrom's reduced earnings forecast. Over the long run, though, there really isn't a retailer that can supplant Nordstrom in that designer brand niche retailing category. If you're in Nordstrom for the long term you probably don't have much to worry about.

Foolish roundup
This week's theme is all about push-and-pull. There are certainly positives and negatives with each stock listed -- and I can to some extent understand why short-sellers have flocked to these three stocks -- however, the pessimism surrounding each stock looks to be contained to the very near term. With GlaxoSmithKline's growing line of COPD therapies, Skechers overseas growth, and Nordstrom's rapidly growing e-commerce sales and niche market, these three stocks could all represent intriguing long-term buy, not short-sale, opportunities.

Three retailers set to dominate the world
As Skechers and Nordstrom have decisively shown, the retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only the most forward-looking and capable companies will survive, and they'll handsomely reward investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.


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