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 tend to trend upward 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 indicating that something is off. 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 Sept. 30 to Oct. 15

Short Shares as a % of Float

Tyson Foods (NYSE: TSN  )

62.5%

12.5%

RPM International (NYSE: RPM  )

60.5%

0.9%

Cooper Tire & Rubber (NYSE: CTB  )

58.2%

5.3%

Source: The Wall Street Journal.

Where's the beef (coming from)
Short-sellers have certainly taken a liking to Tyson Foods, the largest meat-processor in the U.S., with the expectation that higher cattle costs and toughening government regulation will boost its expenses and constrain margins. Based on what I've witnessed recently, over the short term I might just agree with those pessimists.

One of the bigger issues facing meat processors this year was legislation which went into effect earlier in the year requiring that meat be labeled to indicate where the animal was born, raised, and slaughtered. While food transparency may be a worthy goal for many, the increased tracking and labeling costs could wreak havoc on Tyson Foods' bottom line over the near term. Thus far, the food industries' lawsuits to stop the legislation have been unsuccessful.

Another factor working against Tyson Foods is increasing meat prices. Earlier this year beef supply hit a 21-year low, which has helped push prices significantly higher. Although Tyson can increase its prices to meet the higher costs, all that will do is push consumers toward other products and away from Tyson, leaving the company between the proverbial rock and a hard place.

With a middling growth rate of 3% to 4% and rising expenses, it might be best to put Tyson back on the grill for now and leave it to short-sellers.

If you build it, RPM will raise its dividend
RPM International is perhaps one of the most stable product-suppliers in the homebuilding and construction sector, yet it seems to find itself drawing the ire of short-sellers on a somewhat regular basis.

The bet against RPM is premised on an assumption that a rise in record-low interest rates would send home-buying and construction demand down and hurt RPM's business, which is reliant on the sale of coatings, sealants, and other building materials. This theory does have some merit: A 125-basis point increase in lending rates earlier this year sent mortgage loan originations plummeting 60% from their peak. But I wouldn't recommend conceding on RPM so easily.

The reason RPM International is so successful is because it caters to a diverse number of sectors, including personal home-buyers and large-scale industrial enterprises, and because it offers a dividend that it has raised for an impressive 40 consecutive years. RPM has also shown the ability to grow its business organically, through volume and price increases, and through earnings-accretive acquisitions like Kirker and Synta, purchased earlier this year. With the company still on pace to grow EPS 10%-14% in fiscal 2014, even with so much U.S. government and growth uncertainty, I'd suggest short-sellers rethink their position and look elsewhere.

What's your return policy?
Compared to Tyson's higher costs and the threat of rising lending rates to RPM, the pessimism surrounding tire manufacturer Cooper Tire & Rubber is readily apparent.

According to a judge's ruling late last week, Apollo Tyres, which offered to purchase Cooper Tires for $35 per share with the expectation that it would complete the transaction by Oct. 4, wasn't contractually obligated to purchase the company for $35. Cooper had sued Apollo for what it believed was a breach of contract; the former accused the latter of delaying negotiations with its United Steelworkers union and acting in bad faith. This ruling essentially puts the entire deal up in the air (as if it weren't already on thin ice) and could wind up resulting in a break-up fee of $112.5 million -- to be paid by Apollo to Cooper -- or Cooper lowering its buyout price considerably.

This whole situation is pretty ugly from an investing standpoint. When Cooper needs to go to court to assert that Apollo should be purchasing it, you know there could be something deeply wrong somewhere along the line.

My suggestion, if you'd like to stay with the tire industry, is to look long and hard at Goodyear Tire & Rubber (NASDAQ: GT  ) . Although Goodyear has already had a monstrous run, rubber prices are still well off their highs, auto sales are soaring, and Goodyear is still arguably cheap at just seven times forward earnings. Considering it has locked its union in at a reasonably low-cost structure, I feel it's the clear pick of choice among tire manufacturers moving forward.

Foolish roundup
This week's theme is really assessing long-term costs. In the case of RPM, its business diversity keeps it among the leaders in the homebuilding and construction supply industry. When it comes to Tyson Foods, while I appreciate its processing diversity, I also worry that higher prices could scare consumers away from buying meat in the interim. Cooper Tire, on the other hand, is mired in an ugly legal battle that investors would be wise to stay away from -- and that short-sellers are keen to pounce on.

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  • Report this Comment On November 12, 2013, at 3:06 AM, EllenBrandtPhD wrote:

    Sean, While your points are very valid, the increased Short may actually be setting the stock up nicely for Longs going into earnings next week.

    That's because:

    *** Rating of the group is permanently higher following the Smithfield acquisition. This is actually the first earnings call following the acquisition going through.

    *** This earnings period, not the last one, is generally TSN's highest of the year.

    *** Comparisons with last year both this quarter and the next two (generally the two lowest quarters) look to be very nice - very, very nice.

    *** TSN has established credibility with its analysts by beating three of the last four quarters, and probably doesn't want to ruin it.

    *** Stock is 95 percent institutional, with almost no retail participation. In fact, it is still not on retail's radar.

    So let us see what we shall see.

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