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.

Source: The Wall Street Journal.

Running dry?
It's tough to imagine that oil-drilling service contractors in any form are having a difficult time securing work at the moment, but that's precisely the case with Transocean, which recently said roughly one-third of the open capacity in deepwater drilling in the Gulf of Mexico would belong to its service rigs.

One of the biggest obstacles currently affecting contract drillers is weaker oil prices, which have relaxed on global-growth slowdown fears, as well as diminishing political tensions in Syria and Iran. Ultimately, oil prices tend to drive exploration, and with prices falling and capital expenditures far too high for many integrated oil and gas companies, cutbacks are being made.

However, once Transocean can get its legal issues relating to the Macondo oil spill in 2010 in the rearview mirror, it could be full sails ahead for this contract service provider. This isn't to say that Transocean won't face challenges, including its hefty $7.2 billion in net debt (which certainly constrains some of its strategic options), but it does have the full expectation that the U.S. will become the largest oil producer in the world by the end of this decade.

The Obama administration has had no qualms about relying on domestic assets to reduce the U.S.'s reliance on foreign sources of energy, which should help buoy Transocean's longer-term contracts. In addition, Transocean's pricing power, despite the contracting weakness of late, remains solid, with deepwater and ultra-deepwater floaters seeing average daily revenue improve approximately 4% in the third-quarter over the previous year. At just nine times forward earnings, short-sellers may have some very short-term ground to stand on, but I don't believe they're making a smart long-term bet.

You've been declined
Payment processing facilitator and prepaid debit-card issuer Vantiv has drawn the ire of short-sellers in recent weeks after slightly missing earnings estimates in the third-quarter despite generally strong results.

For the quarter, Vantiv reported a 14% increase in net revenue, hitting $294.2 million as it saw 9% growth in the total number of transactions and a 5% pop in the amount of revenue collected per transaction. Looking ahead to the fourth quarter, though, Vantiv warned that weaker consumer-spending trends seen late in Q3 could impact its results. Short-sellers took that as their cue to jump on a company currently valued at 37 times its trailing 12-month earnings.

As for me, I think the short-sellers are completely nuts -- and feel free to quote me on that! If there is one financial sector that seems almost impervious to downside action, it's payment processing facilitators and prepaid debit-card processors. Rival MasterCard (MA 1.33%) has noted that 85% of the world's transactions are currently being conducted in cash, so there's an ample double-digit multidecade growth opportunity for all companies big and small to prosper.

In good economic times consumers are going to spend more frivolously and push Vantiv and MasterCard's fees higher. Credit, by all accounts, is also considerably more convenient and safer than carrying cash. However, when consumers tighten their spending, they're still more likely to use credit than dip into their cash, leaving plenty of room for Vantiv, MasterCard, and all payment processors to see transaction expansion.

This recent earnings warning looks like a classic overreaction by short-sellers, as the long-term future of payment processors looks extremely robust on nearly all counts.

Printing profits
It isn't always easy to change the game or investors' perception of your company, as printing and IT specialist Xerox (XRX) has learned recently.

Xerox's third-quarter earnings results brought another round of jeers from investors, with the company guiding its fourth-quarter profits below forecasts after announcing yet another round of restructuring moves highlighted by more cost-cutting. Xerox, best known for its legacy print business, has been attempting to push into other service-oriented businesses outside printing in order to stem the stagnant revenue from the printing industry. These restructuring moves could signal that things aren't going as planned, although I'd tend to disagree.

Xerox is actually one of the best performers in my One Person's Trash Is Another Person's Treasure portfolio because of its rapid transformation, which makes it a prime beneficiary of the Obamacare health reform. Xerox is handling everything from processing Medicaid claims to handling state funds being paid to individual states from the federal government, and was even the primary architect behind Nevada's state-run health insurance exchange. Xerox is also one of the largest electronic toll-booth operators in the country, recently winning a $100 million, five-year award from the state of Texas.

What Xerox may now lack in top-line growth should soon be made up with an aging population and a surge in insured patients because of Obamacare. Couple that growth in health care with a dividend that's currently yielding 2%, and you have a pretty good reason to stay away as a short-seller.

Foolish roundup
This week's theme is really all about breaking down the barriers between short-term and long-term investing. All three companies above have expressed concerns about growth in the upcoming quarter, but there aren't many growth concerns when you look out a year or longer. Short-sellers would probably be wise to re-evaluate their boosted positions in all three aforementioned companies.