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, between 1983 and 2006, even with dividends included, 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 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 Oct. 31 to Nov. 15

Short Shares as a % of Float

Chimera Investment (NYSE: CIM  )

49.5%

2.4%

Michael Kors (NYSE: KORS  )

98.6%

7%

T-Mobile (NYSE: TMUS  )

66.8%

4.6%

Source: The Wall Street Journal 

Losing interest
Next to the housing and banking industries, few sectors are more susceptible to interest-rate movements than mortgage-REITs, better known as mREITs. Mortgage-REITs make profits on the difference of the rate at which they borrow and the rate at which they lend. In recent months, this figure has been shrinking dramatically with the end of the Federal Reserve's monthly $85 billion bond-buying program well in sight, which has caused investors to lead a mass exodus out of the mREIT sector and its -- up until this point -- double-digit-dividend yields.

For Chimera Investment, a company that purchases agency and nonagency-backed securities, the potential for a rise in interest rates due to the imminent end of QE3 could actually represent an intriguing buying opportunity.

What really intrigues me is Chimera's reliance on nonagency loans, which could be a positive differentiating factor. Whereas agency-backed mREIT's such as Annaly Capital Management (NYSE: NLY  ) purchase only government-backed securities that protect them against default, Chimera is able to invest in higher-yielding securities that give it a bit more risk but also more reward. In other words, Chimera is considerably more tied to the fate of the economy than Annaly Capital Management, which has few default fears. With the unemployment rate falling and U.S. GDP growth coming in stronger than expected for the third quarter, Chimera's net-interest-rate spread may be higher than analysts are currently forecasting.

Conversely, if the U.S. economy were to turn negative, Chimera would be a company I would clearly want to swap out with Annaly Capital, which would likely head higher as investors turned toward more defensive names within the sector. As it stands now, though, short-sellers may want to rethink their pessimism on Chimera.

No sale here
Welcome aboard the Michael Kors retail experience -- please keep all appendages inside the vehicle while it's in motion! OK, perhaps I'm being a bit facetious, but that's certainly what it must feel like as a short-seller of this brand-name-retail juggernaut, which has been practically unstoppable since going public.

In Michael Kors' most recent quarterly results it delivered a 23% increase in same-store sales while wholesale revenue jumped 30% and licensing revenue increased 65%. What's more interesting is that Michael Kors has been able to grow rapidly while pushing into austerity-ravaged Europe and without any type of major promotional activity. This demonstrates just how driven consumers are to own brand-name products that convey luxury without paying a four-digit price.

But having worked in retail myself and followed the industry for better than a decade, I also know that fashion tends to be fleeting, and no company, not even the great Michael Kors, can keep up this torrid pace of growth.

One factor investors may want to consider, this year especially, is how badly teen retailers struggled during the back-to-school season. Usually back-to-school sales give us a good precursor of what to expect for the remainder of the holiday season. Based on what I'm seeing, this would mean consumers are holstering their cash and waiting for deep discounts -- not something you'll find at Michael Kors.

Optimists also may not want to overlook the allure of rewards programs, which help boost sales. Without any major loyalty-rewards programs, Michael Kors, which is predominantly a mall-based retail outlet, may struggle to attract shoppers this holiday season. I'm not calling for a crash by any means, but I'm simply saying at some point very soon the short-sellers will likely be victorious.

A major disconnect
It has certainly been a year of megamergers in the telecom sector. T-Mobile gobbled up MetroPCS, AT&T purchased Leap Wireless, Verizon (NYSE: VZ  ) purchased its unowned stake of Verizon Wireless from Vodafone, and SoftBank became the majority owner of Sprint. The end result is a consolidation of spectrum and a synergy of costs to better go after next-generation customers who want 4G LTE service on their smartphones and tablets.

Ultimately, everyone is chasing Verizon, which has more 4G LTE-capable cities covered under its network than the next three carriers combined. This is a strong selling point for Verizon to lure in new customers and also gives it superior pricing power relative to its peers.

T-Mobile, on the other hand, is doing its best to play catch-up, but it's having to deal with more than its fair share of higher costs. Keep in mind that MetroPCS's CDMA network will be shut down by T-Mobile by 2015 and the company will move all remaining spectrum to its 4G LTE network. That's a mammoth project that is going to cost T-Mobile a pretty penny. In fact, T-Mobile has missed Wall Street's earnings expectations by a mile in four straight quarters due to MetroPCS-related integration costs.

Even if T-Mobile successfully completes this integration ahead of schedule, we're looking at a company that's valued at 46 times next year's earnings and that probably can't grow organically any quicker than 5%. That's a major disconnect between investor optimism and T-Mobile's actual results. It's also enough for me to suggest that short-sellers are right to be concerned about its current valuation.

Foolish roundup
This week's theme was really more about the intangibles associated with these three companies than anything else. For Chimera, it's about recognizing that its higher-risk-loan portfolio is actually a blessing in a growing and improving economy. In the case of Michael Kors, it's realizing that a more skittish consumer and a lack of loyalty rewards could come back to hurt its rapid-growth trend this holiday season. Finally, for T-Mobile, it's realizing that it will have to spend a fortune just to catch up to its larger peers Verizon and AT&T.

The stock short-sellers would be wise to avoid in 2014
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